THE 

ARTHUR  YOUNG 

ACCOUNTING 

COLLECTION 


Graduate  School  of 
Business  Administration 

Library  of  the 

University  of  California 

Los  Angeles 


STAT 


library 
Graduate  School  of  Business  Administration 

University  of  California 
Los  Angeles  24,  California 


PRINCIPLES  OF 
COST  ACCOUNTING 


BY 


JOHN  R.  WILDMAN,  M.C.S.,  CP.A. 

PROFESSOR  OF  ACCOUNTING  IN  THE  NEW  YORK  UNIVERSITY. 
SCHOOL  OF  COMMERCE,  ACCOUN1S  AND  FINANCE 


1916 

NEW  YORK  UNIVERSITY  PRESS 

WASHINGTON  SQUARE  EAST 

NEW  YORK 

40036 


COPYRIGHT,  1911,  BY 
JOHN  R.  WILDMAN 


The  William  G.  Hewitt  Press 
Brooklyn.   New  York 


C8W6 


PREFACE 

The  motive  which  prompted  the  author  to  prepare  and 
publish  Cost  Accounting,  was  the  desire  to  supply  a  demand 
for  a  text  book  on  the  part  of  the  students  in  New  York 
University  School  of  Commerce,  Accounts  and  Finance.  In 
presenting  it  for  public  consideration  it  is  desired  to  have 
clearly  understood  the  fact  that  it  is  intended  as  a  text  book 
especially  adapted  to  the  needs  of  students,  and  is  not  in- 
tended as  a  general  reference  work. 

The  supply  of  literature  on  the  subject  of  cost  account- 
ing is  increasing  rapidly.  The  quality  of  such  literature  is 
of  a  high  order.  The  fault  to  be  found  with  it  from  the 
point  of  view  of  a  teacher  is  that  it  is  too  highly  specialized. 
The  tendency  on  the  part  of  authors  on  this  subject  is  to 
select  some  particular  industry  or  line  of  production  and 
describe  a  particular  system,  attempting  to  make  such  typical 
of  the  entire  subject. 

Most  systems  are  accompanied  by  elaborate  forms.  In 
fact  it  may  be  said  that  many  systems  are  nothing  more  than 
a  collection  of  forms.  This  practice  has  been  carried  to 
such  an  extent  that  it  would  not  be  extravagant  to  state  that 
the  average  student  looks  upon  the  study  of  cost  accounting 
as  a  matter  of  becoming  familiar  with  certain  specific  forms 
comprising  a  particular  system.  In  this  maze  of  forms  the 
student  becomes  lost  and  the  principles  underlying  the  forms 
are  entirely  overlooked. 

During  the  first  few  years  of  the  author's  experience  in 
accounting  work  he  devoted  a  great  deal  of  time  to  collect- 

iii 


Preface 

ing  forms  of  all  kinds,  especially  those  having  to  do  with 
cost  accounting.  After  having  collected  enough  to  half  fill 
a  medium  sized  steamer  trunk  he  discontinued  the  practice. 
There  were  two  reasons  why.  Being  always  so  busy  col- 
lecting them  he  never  had  time  to  refer  to  them.  When  he 
had  occasion  to  devise  and  use  a  form  he  constructed  it 
anew  without  reference  to  his  collection.  Having  deter- 
mined the  subject  for  which  the  form  was  needed  and 
considering  the  use  to  which  it  was  to  be  put,  it  was  only 
necessary  to  make  the  form,  through  its  construction  and 
arrangement,  call  for  the  information  desired.  Experience 
taught  him  that  a  knowledge  of  what  the  form  should  recite 
was  of  vastly  more  value  than  familiarity  with  any  particu- 
lar form,  or  than  to  be  able  to  refer  to  a  splendid  collection. 
Little  attention  has  been  given  to  forms  in  the  prepara- 
tion of  this  book.  It  is  essentially  a  book  setting  forth  the 
principles  of  cost  accounting  rather  than  a  treatment  of  the 
subject  in  all  its  refinements.  To  the  experienced  cost  ac- 
countant it  will  be  of  little  value.  To  the  engineer  dealing 
with  cost  accounting  problems  it  will  be  of  less  value.  To 
the  student,  whether  in  the  technical  school  of  some  univer- 
sity, or  in  the  works  department  of  a  plant  in  some  small 
manufacturing  town,  it  is  hoped  that  this  book  may  give  a 
broader  conception  of  the  subject,  impress  the  principles  un- 
derlying it  firmly  upon  his  mind,  and  so  prepare  him  that  he 
mey  attack  intelligently  and  successfully  the  problems  which 
confront  him  and  read  and  study  to  better  advantage  some 
of  the  more  interesting  literature  now  available  and  being 
prepared  by  specialists  in  this  line  of  work. 

JOHN  RAYMOND  WILDMAN. 
New  York, 
June  4,  1910. 

iv 


CONTENTS 


CHAPTER  PAGE 

I. — OBJECTS  IN  ASCERTAINING  COST I 

II. — CLASSIFICATION  OF  COSTS 5 

III. — SELECTION  OF  A  SYSTEM 9 

IV. — ACCOUNTING  COST  SYSTEM 12 

V. — MANUFACTURING  OR  FACTORY  COST  SYSTEM  18 

VI. — ORDERS 26 

VII. — MATERIALS  AND  SUPPLIES 31 

VIII.— LABOR 37 

IX. — OVERHEAD 44 

X. — TYPES  OF  MANUFACTURING  COST  SYSTEMS       ....  50 
XI. — WHEN  DEPARTMENTAL  DISTRIBUTION  OF  OVERHEAD  is  INDI- 
CATED       54 

XII. — DEFECTIVE  GOODS,  WASTE,  SHRINKAGE  AND  IDLE  TIME  .       .  58 

XIII. — DISTRIBUTABLE  OVERHEAD  AND  BASES  OF  DISTRIBUTION    .        .  63 

XIV. — MACHINE  RATES 67 

XV. — WAGE  SYSTEMS           71 

XVI. — FIXING  OF  WAGE  RATES 79 

XVII. — THE  EFFICIENCY  DEPARTMENT 81 

XVIII. — RECONCILING  PREDETERMINED  AND  ESTIMATED  COSTS  WITH 

ACTUAL  COSTS 88 

XIX. — REPORT  OF  THE  COST  DEPARTMENT 93 


Principles  of  Cost  Accounting 

CHAPTER  I 

THE  OBJECTS  IN  ASCERTAINING  COST 

A  discussion  of  the  subject  of  Cost  Accounting  involves 
the  consideration  of  three  topics  : 

1 i )  The  nature  of  the  information  being  sought. 

(2)  The  means  of  obtaining  the  information. 

(3)  The  use  to  which  the  information  is  to  be  put,  after 
it  is  obtained. 

A  consideration  of  the  first  topic  requires  an  inquiry  into 
the  objects  in  ascertaining  costs.  Briefly  stated  they  are  as 
follows : 

(a)  To  ascertain  whether  or  not  a  business  undertaking 
is  profitable. 

(b)  To  serve  as  a  basis  for  fixing  selling  prices. 

(c)  To  furnish  information  to  the  proprietor  or  admin- 
istrative officer  which  will  guide  him  in  forming  his  adminis-* 
trative  judgment. 

In  the  simplest  of  business  transactions  the  interesting 
element  is  that  of  profit  A  man  who  undertakes  a  business 
venture  of  any  kind  is  primarily  interested  in  knowing 
whether  he  is  making  or  losing  money.  In  either  case,  how 
much?  He  is  secondarily  interested  in  Knowing  whether  his 
business  is  sufficiently  profitable.  By  this  is  meant,  whether 
or  not  the  return  on  the  investment  is  up  to  the  average  for 
the  line  of  business  in  which  he  is  engaged. 

I 


Principles  of  Cost  Accounting 

If  he  is  engaged  in  trading,  his  first  or  gross  profit  is 
from  the  sale  of  his  merchandise.  In  order  to  ascertain  his 
profit  he  must  oppose  against  the  proceeds  of  his  sales  the 
cost  thereof.  If  his  cost  is  incorrect,  his  profit  is  incorrect. 
Strangely  enough,  the  error  in  such  cases  is  usually  against 
him  rather  than  in  his  favor.  Such  errors  frequently  re- 
peated are  inclined  to  lead  him  suddenly,  and  often  to  his 
surprise,  into  a  condition  of  insolvency.  Hence  the  import- 
ance, even  in  the  simplest  transactions,  of  having  informa- 
tion on  the  subject  of  cost  which  is  correct  and  trustworthy. 

Competition  as  it  exists  today  calls  for  the  greatest  of 
care  in  fixing  selling  prices.  The  exercise  of  such  care  re- 
quires business  experience,  a  knowledge  of  business  condi- 
tions and  reliable  information  concerning  costs.  The  suc- 
cessful contractor  is  the  man  who  not  only  gets  the  contract 
by  virtue  of  having  submitted  the  lowest  reasonable  bid, 
other  things  being  equal,  but  the  man  who  can  get  his  profit 
out  of  the  contract  after  he  has  succeeded  in  securing  it. 

If  a  loss  results,  or  the  margin  of  profit  is  too  small,  it 
means,  upon  repetition,  one  of  two  things  must  be  done; 
either  the  selling  price  must  be  increased,  or  the  cost  must 
be  decreased. 

Of  these  two  expedients,  the  first  is  usually  inadvisable, 
if  not  impossible,  without  resulting  in  a  loss  of  business,  and 
the  business  man  looks  to  the  second  means  for  relief.  Can 
he  use  this  means  intelligently  if  he  is  not  absolutely  sure  of 
his  cost?  Obviously,  not! 

Through  the  aid  of  accurate  information  concerning 
costs  the  proprietor  or  administrative  officer  is  enabled  to 
keep  in  close  touch  with  conditions,  shape  the  operating 
policy  of  the  future  and  guide  the  operations  as  they  mature. 

He  is  enabled: 

2 


The  Objects  in  Ascertaining  Cost 

a.  To  determine  which  lines  of  production  or  merchan- 
dise are  profitable  and  which  are  unprofitable;  to  institute 
methods  for  extending  and  increasing  the  sale  of  such  lines 
as  are  profitable  and  to  retard  the  sale  of,  or  withdraw  en- 
tirely from  the  manufacture,  or  sale  of,  such  lines  as  are 
unprofitable;  to  decide  intelligently  the  lines  on  which  com- 
missions may  be  allowed  to  salesmen  and  the  extent  of  such 
commissions. 

b.  To  reduce  costs;  either  through  a  reduction  of  the  ele- 
ments composing  costs,  or  through  an  increase  in  the  pro- 
duction. 

c.  To  allocate  "leaks"  and  stop  unnecessary  waste  or  ex- 
travagance. 

d.  To  develop  the  highest  type  of  productive  efficiency. 
To  bolster  up  the  weak  points  and  harmonize  the  work  of 
the  different  departments,  or  operating  groups. 

e.  To  gauge  the  efficiency  of  managers,  relatively  speak- 
ing, by  comparing  one  manager  with  another.     The  man- 
ager, whose  cost  of  producing  soil  pipe  per  ton  is  $7.00,  is 
obviously  not  as  efficient  or  capable  as  the  man  who  under 
precisely  similar  conditions  can  produce  the  same  product  at 
a  cost  of  $5.00  per  ton. 

/.  To  compare  the  work  of  similar  foremen,  depart- 
ments, machines,  operatives,  or  other  centers  of  production. 

g.  To  compare  costs  in  general  of  one  period  with  an- 
other. 

h.  To  compare  actual  costs  with  estimated  or  predeter- 
mined costs.  The  tendency  today  is  toward  standardization. 
Generally  speaking  from  the  standpoint  of  costs,  standards 
are  unattainable.  A  comparison  of  actual  costs  with  stand- 
ard costs  determines  the  percentage  of  efficiency. 

Modern  business  organization  has  become  so  complex 

3 


Principles  of  Cost  Accounting 

as  to  have  passed  beyond  the  limits  of  individual  observa- 
tion, unless  the  individual  has  some  artificial  means  of  tran- 
scending these  limits.  The  time  has  passed  when  the  admin- 
istrative officer  can  be  in  touch  with  all  the  details  of  the 
business.  Cost  statistics  offer  such  a  man  a  means  of  tran- 
scending his  individual  limits.  They  afford  him  an  opportu- 
nity of  having  placed  before  him  at  stated  intervals  a  picture, 
as  it  were,  of  his  business  operations.  The  administrative 
officer,  or  proprietor,  draws  his  conclusions  from  the  pic- 
ture, and  is  afforded  thereby  a  basis  on  which  to  found  his 
judgment  as  to  future  operations  and  policies.  It  is  said  of 
the  late  Mr.  Harriman,  that  he  owed  his  success  in  a  meas- 
ure to  his  ability  to  interpret  the  operations  of  his  many 
business  enterprises  from  the  statistical  reports  which  he  re- 
quired of  his  representatives  from  time  to  time. 


4 


CHAPTER  II 

CLASSIFICATION  OF  COSTS 

Costs  are  frequently  referred  to  without  distinction  as 
to  whether  manufacturing  or  selling  costs  are  meant.  That 
such  a  distinction  should  be  made  is  important.  Manufactur- 
ing cost,  as  will  be  seen  in  the  classification  appearing  below, 
contemplates  only  such  costs  as  arise,  in  the  factory,  in  con- 
nection with  the  manufacture  of  the  product.  Selling  cost 
has  as  its  basis  the  manufacturing  cost,  to  which  is  added  the 
expense  of  selling  the  product,  the  expense  of  administration, 
and  all  other  items  of  expense  incident  to  the  conduct  of  the 
business.  The  trader,  who  buys  and  sells  merchandise,  tech- 
nically speaking,  has  no  manufacturing  cost.  His  is  a  selling 
cost,  having  as  a  basis,  however,  an  item  of  cost  of  purchase, 
corresponding  relatively  to  the  cost  of  manufacture. 

The  details  of  each  class  of  costs  are  as  follows : 

1.  Manufacturing  costs,  composed  of 

Prime  cost  and 

Manufacturing  overhead,  variously  referred  to  as 
Factory  loading 
"       burden 
expense 
indirect 

Manufacturing  expense 
"On  cost." 

2.  Selling  costs,  the  elements  of  which  are 

(a)   Manufacturing  cost 


Principles  of  Cost  Accounting 

(b)  Selling  expense 

(c)  Administrative  expense 

(d)  Fixed  charges  or  capital  expenses 

(e)  Provisions  for  reserves 
(/)    Deductions  from  sales. 

A   somewhat  more   detailed   analysis   of   selling  costs 
would  include  the  following  items : 
A.  Manufacturing  cost 

1.  Prime  cost 

(a)  Materials  and  supplies,  including 

inward  freight  and  cartage,  and  duty 

(b)  Labor — direct — such  as 

"cutting  out  "  and  "stitching"  in  the 
manufacture  of  shoes. 

2.  Manufacturing  overhead 

(a)  Labor — indirect 

Foremen 

Helpers  (not  working  on  product) 

Porters 

Watchmen 

Messengers 

Teamsters 

(b)  General  factory  expense 

Heat,  light  and  power 
Shop  supplies  (so  small  as  not  to  war- 
rant charging  to  stock) 
Repairs  and  renewals 
Office  supplies 
Office  expenses 

(c)  Salaries 

Manager  or  superintendent 
Clerks — keeping  factory  records 
6 


Classification  of  Costs 

(d)   Depreciation  of  machinery  and  tools,  or 
other  operating  equipment 

B.  Selling  expense 

(1)  Salesmen 

Salaries 

Traveling  expense 
Commissions 

(2)  Advertising 

C.  Administrative  expense 

1 i )  Salaries 

Officers 

Clerks — keeping  general  records 

(2)  Expense — general  office 

Printing  and  stationery 

Postage 

Telephone  and  telegraph 

Traveling — officers  and  clerks 

Legal 

Miscellaneous 

D.  Expenses  of  capital — (subject  to  offset  on  account  of 

other  income) 
'(i)    Cash  discount  on  sales 

(2)  Rent 

(3)  Taxes 

(4)  Insurance 

( 5 )  Interest 

E.  Provisions  for  reserves 

1 i )  Defective  goods  returned 

(2)  Doubtful  accounts 
(3)    Depreciation  of  plant 

F.  Deductions  from  sales 

(i)   Allowances 

7 


Principles  of  Cost  Accounting 

(a)  Loss 

(b)  Breakage 

(c)  Damage 

(2)  Trade  discounts 

(3)  Rebates 

(4)  Outward  freight 

The  above  outline  is  intended  to  be  indicative  rather 
than  exhaustive. 

The  relation  of  selling  cost  to  selling  price,  the  elements 
of  which  are  cost  and  profit,  may  be  made  apparent  by  the 
following  illustration : 

SELLING  PRICE 


Deductions  from  Sales 


I  Provisions  for  Reserves 


|    Expenses  of  Capital 


PROFIT  |    Administrative  Expense 


|    Selling  Expense 


(    Manufacturing  Overhead 
f    Prime  Cost 


8 


CHAPTER  III 

THE  SELECTION  OF  A  SYSTEM 

Having  determined  the  nature  and  extent  of  the  infor- 
mation sought,  the  question  of  how  it  is  to  be  obtained 
arises.  What  kind  of  accounting  mechanism,  or  system, 
shall  be  employed  for  this  purpose  ? 

Product  differs.  What  will  serve  in  one  case  may  not 
serve  in  another.  Hence  in  order  to  decide  intelligently  as 
to  the  means  to  be  employed  in  obtaining  the  required  in- 
formation it  will  be  necessary  to  study  the  question  of  pro- 
duction with  regard  to  the  type  of  product  and  try  to  dis- 
cover certain  characteristics  common  to  the  various  types. 

If  a  baker  were  to  mix  up  a  batch  of  dough,  consisting 
of  flour,  eggs,  milk,  sugar,  butter,  baking  powder,  salt  and 
flavoring,  roll  it  out  on  a  board  and  cut  crullers  therefrom, 
each  ring  of  dough  would  contain  the  same  quantity  of  in- 
gredients and  have  resulted  from  the  same  operations  of 
labor.  All  having  come  from  the  same  batch  of  dough,  there 
could  be  no  dissimilarity  in  the  quality  of  the  ingredients. 

If  it  were  desired  to  find  the  cost  per  dozen  crullers,  the 
cost  of  the  ingredients,  the  labor  and  any  expense  like  lard 
for  frying,  and  heat,  would  be  combined  and  the  amount 
divided  by  the  number  of  dozen  crullers  resulting  from  the 
batch.  This  process  may  be  repeated  indefinitely  and  the 
result  will  always  be  the  same,  subject  to  fluctuation  in  the 
cost  of  the  elements,  namely,  an  average  cost  per  unit.  The 
unit  will  have  remained  the  same  throughout  and  the  elements 

9 


Principles  of  Cost  Accounting 

which  the  unit  represents  will  likewise  have  remained  the 
same.  The  operations  will  have  been  confined  to  the  pro- 
duction of  a  single  thing  of  a  certain  grade.  Hence  the  term 
single  unit  production  may  be  used  to  describe  this  and  simi- 
lar situations.  By  single  unit  production  is  meant  that  class 
of  production  in  which  the  units  produced  are  identical  with 
regard  to  the  kind,  quantity  and  quality  of  material  used, 
require  the  same  operations  of  labor  and  share  equally  in 
the  distribution  of  the  overhead.  Single  unit  production  is 
always  attended  by  a  uniform  cost  per  unit  and  as  a  rule 
by  a  uniform  sales  price. 

If  a  manufacturer  were  engaged  in  producing  steamer 
trunks,  wardrobe  trunks  and  sample  trunks  for  salesmen, 
it  is  doubtful  if  any  one  having  to  fix  the  sales  prices 
would  take  the  average  cost  price  of  a  collective  batch 
of  these  trunks.  True,  they  are  all  trunks,  but  they 
are  sufficiently  unlike  to  make  it  necessary  to  consider 
their  cost  separately.  The  wardrobe  trunk  and  sample  trunk 
are  larger  than  the  steamer  trunk  and  contain  much  more 
material.  The  wardrobe  trunk  is  more  extensively  fitted 
while  the  sample  trunk  is  strongly  built  and  reinforced  in 
order  to  withstand  the  severe  and  almost  constant  handling 
to  which  it  is  subjected.  Thus  it  will  be  seen  that  not  only 
does  the  material  differ  but  the  peculiarities  of  the  different 
trunks  call  for  operations  of  labor  which  vary  in  their  char- 
acter and  extent.  These  variations  affect  the  distribution  of 
the  overhead  in  the  various  cases  and  the  result,  if  properly 
obtained,  is  cost  on  what  might  be  said  to  be  three  classes  of 
product.  The  dissimilarity  is  almost  as  marked  as  if  the 
manufacturer  were  producing  trunks,  traveling  bags  and 
umbrellas. 

In  the  latter  case  no  one  would  question  the  statement 

10 


The  Selection  of  a  System 

that  there  were  three  classes  of  units.  With  equal  facility  it 
should  be  seen  that  the  situation  is  the  same  in  the  former 
case.  The  units  are  all  trunks,  but  they  may  be  so  entirely 
different  with  regard  to  the  kind,  quantity  and  quality  of 
material  and  the  operations  of  labor  that  they  may  be  consid- 
ered as  units  differing  entirely  in  their  nature. 

To  describe  such  a  situation,  where  the  manufacture  is 
confined  to  one  article  but  the  article  varies  in  size,  quantity 
or  quality  of  material,  or  operations  of  labor,  or  where  the 
manufacture  extends  to  different  classes  of  articles,  the  term 
multiple  unit  production  may  be  used.  Multiple  unit  pro- 
duction is  attended  by  various  unit  costs  and  various  sales 
prices. 

Production,  then,  as  used  in  its  relation  to  cost,  may  be 
classified  as : 

Single  unit 
Multiple  unit 

The  selection  of  the  system  to  be  employed  in  securing 
the  desired  information  concerning  the  cost  will  depend 
upon  the  kind  of  production  involved. 

Where  the  elements  of  cost  may  be  thrown  together  and 
divided  by  the  number  of  units  produced,  because  one  unit 
is,  for  practical  cost  purposes,  like  every  other  unit,  one 
system,  very  simple  in  its  character,  will  suffice.  Where  the 
elements  of  cost  must  be  grouped  in  accordance  with  the 
segregation  of  units  before  division  may  be  made,  a  different 
system,  and  one  far  more  complicated,  is  indicated. 

The  systems  available  for  use,  and  which  will  be  de- 
scribed in  detail  in  subsequent  chapters,  are  as  follows : 
The  accounting  cost  system 
The  manufacturing  (or  factory)  cost  system 


ii 


CHAPTER  IV 

THE  ACCOUNTING  COST  SYSTEM 

The  accounting  cost  system  is  the  simpler  of  the  two,  in 
that  it  involves  no  books  other  than  those  usually  embraced 
in  the  system  of  financial  accounts.  For  this  reason  the  ac- 
counting cost  system  is  sometimes  referred  to  as  a  "finan- 
cial" cost  system.  It  contemplates  a  complete  and  compre- 
hensive classification  of  operating  accounts  in  the  general 
ledger  such  as  were  shown  in  the  outline  covering  the  ele- 
ments of  selling  cost.  The  arrangement  of  the  accounts  is 
somewhat  changed,  however,  in  order  that  the  financial  oper- 
ations may  be  clearly  brought  out  and  the  source  of  profits 
allocated  in  preparing  statements  from  the  books.  The 
asset  and  liability  accounts  appear  in  the  general  ledger  as 
usual  and  the  trial  balance  of  same  furnishes  the  information 
necessary  to  prepare  the  balance  sheet  and  statement  of 
income  and  profit  and  loss.  It  is  essential  that  the  latter 
should  be  tied  into  the  balance  sheet  in  order  to  prove  its 
mathematical  correctness,  and  it  is  the  statement  which  be- 
comes the  basis  of  the  cost  sheet 

In  addition  to  the  work  contemplated  by  the  ordinary 
system  of  accounting  it  is  necessary  that  a  record  should  be 
kept  of  the  units  sold  and  the  units  returned  in  order  that 
the  net  sales  in  units  may  be  ascertained.  If  the  cost  of  net 
sales  is  obtained  and  the  number  of  net  units  sold  is  known, 
it  is  obvious  that  by  dividing  cost  by  units  an  average  cost 
per  unit  may  be  obtained.  It  is  true  of  course  that  the  cost 

12 


The  Accounting  Cost  System 

may  be  slightly  inaccurate  on  account  of  not  selling  in  every 
case  the  physical  units  produced  during  the  period,  but  if 
the  units  are  of  the  same  type  the  objection  to  the  discrep- 
ancy will  be  so  slight  as  to  be  almost  nil  when  compared 
with  the  saving  in  time  and  expense  which  the  use  of  the 
system  accomplishes. 

It  will  be  seen  from  the  following  statement  of  income 
and  profit  and  loss  that  the  accounting  cost  system  may  be 
adapted  to  single  unit  production  and  afford  to  the  adminis- 
trative officer  an  excellent  picture  of  the  operation  of  the 
business  and  a  basis  for  administrative  judgment.  General 
captions  have  been  principally  used  here  in  order  to  con- 
dense the  statement,  but  it  should  be  understood  that  in 
practice  the  statement  should  embody  all  the  detail  accounts 
as  set  forth  in  the  analysis  of  selling  costs. 


Principles  of  Cost  Accounting 


STATEMENT  OF  INCOME  AND  PROFIT  AND  LOSS  FOR  THE 
PERIOD  ENDED.. 


Units 

Money 
Values 

Cost  Statistics 
Average  per  Unit 

Less  returns  

Deduction  from  sales  : 
Trade  discounts  

Allowances  : 
Breakage  

Damage  

Loss   

Outward  freight  and  cartage.... 
Total  

Income  from  sales  

Cost  of  sales  (deduct)  : 
Materials  and  supplies  consumed 
Labor  —  Direct       

Manufacturing  overhead  

Difference  in  inventory  of  goods 
in  process  

Difference  in  inventory  of  finished 
goods   

Total  

Gross  profit  on  sales  

Selling  expense   (deduct)  

Selling  profit  

Administrative  expense  (deduct).. 

Net  profit  on  sales  —  Income  from 
operation  



Other  income  (add)  

Total  Income  

Deductions  from  income  

Net  income  —  profit  and  loss  

Profit  and  loss  credits  (add)  

Total  

Profit  and  loss  charges  (deduct).. 

Profit  and  loss  surplus  for  the  period 
Profit  and  loss  surplus  —  beginning 
of  period  (add)  



Profit  and  loss  surplus  (per  balance 
sheet  

The  Accounting  Cost  System 

In  connection  with  the  preceding  statement,  a  discussion 
may  be  had  with  advantage  of  the  second  section,  or  that 
dealing  with  the  cost  of  sales.  It  is  important  that  the  rela- 
tion between  the  items  making  up  the  cost  of  sales,  as  shown 
in  the  statement,  and  the  same  items,  as  they  are  found  in 
the  subsidiary  records,  should  be  clearly  established.  The 
materials  and  supplies  shown  in  the  statement,  are  the  ma- 
terials and  supplies  consumed  in  the  manufacture  of  the 
product.  The  figure  representing  consumption  is  arrived 
at  by  starting  with  the  inventory  of  materials  and  supplies 
on  hand  at  the  beginning  of  the  period,  adding  thereto  the 
purchases  during  the  period,  and  deducting  from  the  total 
of  such  amounts,  the  inventory  on  hand  at  the  end  of  the 
period.  The  consumption  of  materials  and  supplies,  to- 
gether with  the  direct  labor  and  manufacturing  overhead  for 
the  period,  passes  over  theoretically  into  the  account  repre- 
senting goods  in  process.  The  consumption  might  have  been 
arrived  at  by  applying  to  the  purchases  the  difference  be- 
tween the  inventory  at  the  beginning,  and  the  inventory  at 
the  end  of  the  period.  If  the  inventory  at  the  end  of  the 
period  is  greater  than  at  the  beginning  of  the  period,  ob- 
viously, all  materials  and  supplies  purchased  have  not  been 
consumed  and  the  purchases  are  subject  to  a  decrease  on 
account  of  the  increase  in  the  inventory.  Where  conditions 
are  the  reverse,  the  purchases  are  subject  to  increase  on 
account  of  the  decrease  in  the  inventories,  for  the  reason 
that  more  materials  and  supplies  have  been  consumed  during 
the  period  than  were  purchased. 

The  cost  of  the  goods  in  process  which  during  the  period 
have  been  completed  and  transferred  to  finished  goods,  is 
arrived  at  step  by  step,  through  the  following  accounting 
processes.  To  the  value  of  the  inventory  of  goods  in  process 

15 


Principles  of  Cost  Accounting 

at  the  beginning  of  the  period,  there  is  added  an  amount 
combining  the  materials  and  supplies  consumed,  the  direct 
labor  expended,  and  the  manufacturing  overhead.  From 
the  total  of  these  amounts  there  is  deducted  the  value  of  the 
inventory  of  goods  in  process  on  hand  at  the  end  of  the 
period.  The  result  obtained  by  these  processes  gives  the 
value  of  the  goods  which  have  been  finished  and  transferred 
to  stock  during  the  period.  The  same  result  might  have 
been  obtained  by  applying  to  the  combined  values  of  mate- 
rials and  supplies  consumed,  direct  labor,  and  manufacturing 
overhead,  collectively,  the  increase  or  decrease  in  the  inven- 
tories of  goods  in  process,  at  the  beginning  and  at  the  end 
of  the  period,  respectively. 

The  cost  of  the  goods  sold  is  obtained  from  the  treat- 
ment of  the  finished  goods  account  in  a  manner  similar  to 
the  preceding;  namely,  adding  to  the  inventory  of  finished 
goods  on  hand  at  the  beginning  of  the  period  the  value  of 
the  goods  transferred  to  finished  stock  during  the  period, 
and  deducting  from  the  total  of  such  values  the  inventory  of 
finished  goods  on  hand  at  the  end  of  the  period.  The  prin- 
ciple of  applying  to  the  value  of  the  goods  transferred  dur- 
ing the  period  the  increase  or  decrease  in  the  inventories  of 
finished  goods  may  be  carried  out  as  well  with  this  account 
as  with  the  materials  and  supplies  and  the  goods  in  process 
accounts. 

From  the  foregoing,  the  thoughtful  reader  will  doubtless 
have  reached  the  conclusion  that  the  same  result  may  be 
arrived  at,  by  treating  the  items  involved  in  the  cost  of  manu- 
facture during  the  period  with  the  increases  and  decreases  in 
the  inventories  of  both  goods  in  process  and  finished  goods. 
If  to  the  purchases,  after  having  been  treated  with  the  dif- 
ference in  inventories  of  materials  and  supplies,  there  is 

16 


The  Accounting  Cost  System 

added  the  cost  of  direct  labor  and  the  manufacturing  over- 
head and  the  total  of  such  three  items  is  then  affected  by  the 
difference  in  inventories  of  the  goods  in  process  and  the  fin- 
ished goods,  the  result  will  be  precisely  the  same  as  that 
obtained  by  going  through  the  accounts  step  by  step  and 
following  each  operation.  A  careful  study  of  the  following 
tabulations  will  undoubtedly  serve  to  bring  out  the  thoughts 
which  the  above  remarks  intend  to  convey. 


Materials 
and 
Supplies. 

Labor 
Direct. 

Manufac- 
turing 
Overhead. 

Goods  in 
Process. 

Finished 
Goods. 

Inventory   at   beginning   of 
period  

$4..  OOO 

$15  ooo 

$17  ooo 

Purchases  

IO,OOO 

l6,OOO 

19,000 

Total  

I4,OOO 

3I,OOO 

36,000 

Inventory  at  end  of  period  .  . 

6.OOO 



12,000 

9,000 

Consumption  

$8,000 

$6,OOO 

$2,OOO 

$I9,OOO 

$27,000 

\                 / 
$l6,OOO 

Presented  in  the  form  of  a  statement  the  figures  appear  as  follows: 

Purchases $10,000 

Deduct  Increase  in  Inventory  Materials  and  Supplies 2,000 

Consumption $8,000 

Labor — Direct 6,000 

Manufacturing  Overhead 2,000 

Total $16,000 

Add — Decrease  in  Inventory  Goods  in  Process 3,000 

Add — Decrease  in  Inventory  Finished  Goods 8,000 

Cost  of  Goods  Sold $27,000 


THE  MANUFACTURING  OR  FACTORY  COST  SYSTEM 

Where  multiple  unit  production  is  involved,  the  ques- 
tion of  system  becomes  much  more  complex.  More  details 
are  required,  and  consequently  a  more  elaborate  set  of 
books.  General  books  and  general  accounts  are  entirely 
adequate  in  the  case  of  single  unit  production,  but  it  is  im- 
practicable, if  not  absolutely  impossible,  to  obtain  the  neces- 
sary results  in  the  case  of  multiple  unit  production.  The 
accounting  cost  system  answers  the  purpose  so  long  as  noth- 
ing beyond  average  costs  is  required,  but  it  should  be  pointed 
out  that  the  application  of  this  system  might  result  disas- 
trously if  the  identity  of  the  various  units  were  overlooked 
and  average  costs  obtained.  An  average  cost  would  be  en- 
tirely satisfactory  if  accompanied  by  average  sales;  that  is 
to  say,  if  an  equal  amount  of  sales  in  each  of  the  lines  was 
made.  The  average  cost  of  three  (3)  lines  of  production 
at  $14,  $15,  and  $16,  respectively,  might  be  $15,  and  no 
damage  could  result  if  there  were  a  corresponding  average 
sale  of  the  three  (3)  lines.  An  increase  in  the  demand  for 
goods  costing  $16  and  a  decrease  in  the  demand  for  those 
costing  $14  would  materially  alter  the  situation,  and  the 
manufacturer,  having  at  his  disposal  only  the  information 
that  the  average  cost  of  his  three  (3)  lines  of  product  was 
$15,  might  be  unable  to  account  for  the  condition  of  insol- 
vency which  would  very  likely  fall  upon  him. 

In  the  use  of  the  manufacturing  cost  system,  it  is  neces- 

18 


The  Manufacturing  of  Factory  Cost  System 

sary  to  distribute  or  apply  the  material  and  supplies,  labor, 
and  overhead  over  the  various  grades  or  units  of  production, 
and  keep  special  cost  records.  It  is  necessary  to  determine 
the  cost  of  each  grade,  or  quality  of  product.  Each  lot,  or 
unit,  or  group  of  small  units,  must  be  identified,  usually  by 
number,  and  each  traced  through  the  process  of  manufac- 
ture, the  items  of  cost  accumulating  as  the  work  progresses. 

The  proprietor  is  primarily  concerned  with  a  cost  upon 
which  to  base  a  selling  price,  but  he  may  also  desire  infor- 
mation of  a  statistical  nature,  which  will  enable  him  to  gauge 
or  compare  the  efficiency  of  the  management,  or  the  opera- 
tives in  some  particular  division  of  the  work. 

There  are  three  (3)  elements  making  up  the  cost: 
Materials  and  supplies; 
Labor; 
Overheard; 

Manufacturing, 
General. 

The  next  question  is,  how  to  arrange  the  system  so  as  to 
furnish  the  information  as  to  how  much  of  each  element 
goes  into  the  cost  of  the  various  units  in  process  of  manufac- 
ture? 

It  is  usually  conceded  that  a  departmental  organization 
furnishes  the  best  form  for  accomplishing  these  results ;  not 
necessarily  a  physical  division  or  department,  but  at  least 
a  division  so  far  as  the  recording  of  the  operations  is  con- 
cerned. By  placing  each  department  under  the  charge  of 
some  employe,  a  distribution  of  the  supervision  of  the  work 
and  records  is  accomplished  without  complicating  the  ac- 
counting mechanism  and  working  a  hardship  upon  one,  or  a 
small  number  of  employes. 

While  the  matter  of  classifying  manufacturing  cost  sys- 

19 


Principles  of  Cost  Accounting 

terns,  with  regard  to  the  various  types  involved,  will  be  taken 
up  later,  the  author  desires  to  confine  his  remarks  at  the 
present  time  to  a  discussion  of  the  simple  type,  wherein  in- 
formation having  to  do  with  materials  and  supplies,  and 
labor,  is  obtained  by  the  cost  clerk  direct  from  each  depart- 
ment, instead  of  allowing  the  cost  to  accumulate  on  depart- 
mental records  as  the  work  progresses. 

The  work  in  process  is  identified  by  a  system  of  num- 
bers, under  which  each  department  reports  the  charges  for 
material  and  supplies,  and  the  labor  which  it  has  against 
these  numbers.  Where  it  can  be  avoided  the  overhead 
should  not  be  allowed  to  become  involved  in  departmental 
records.  It  is  only  necessary  to  complicate  the  work  of  the 
departments  by  loading  them  with  overhead,  where  statistics 
for  administrative  purposes  are  required  for  the  purpose 
of  judging  or  comparing  the  efficiency  of  a  supervising  oper- 
ative, or  foreman,  a  group  of  operatives,  or  the  work  of  a 
department,  and  such  distribution  is  not  contemplated  in  the 
simple  type  of  system.  If  indicated  by  special  circumstances 
the  records  covering  such  distribution  should  be  made  sub- 
sidiary to  the  general  cost  records,  and  no  department  bur- 
dened with  any  overhead,  which  does  not  originate  there,  or 
fall  under  the  responsibility  or  control  of  the  head  of  the 
department.  The  value  of  statistics  for  administrative  use 
is  destroyed  when,  for  example,  an  attempt  is  made  to  judge 
the  efficiency  of  a  manufacturing  department  by  such  items 
as  salaries  of  officers,  traveling  expenses  of  officers,  or  any 
similar  item  not  specifically  affecting  same. 

Let  it  be  remembered  then,  that  the  departments  are  to 
report  the  charges  which  they  have  against  the  work  in  pro- 
cess to  the  cost  department,  which  should  provide  a  book  in 
which  these  reports  may  be  summarized. 

20 


The  Manufacturing  of  Factory  Cost  System 

The  stores  department  should  be  required  to  furnish  a 
record  of  the  materials  and  supplies  issued,  showing  the 
number  of  the  jobs  or  lots  against  which  they  are  issued. 
This  department  should  keep  a  detailed  record  of  the  cost 
of  the  materials  and  supplies,  the  receipts  and  issues  of 
which  should  be  summarized  in  the  materials  and  supplies 
ledger. 

Labor  departments  report  to  the  cost  department  the 
charges  for  direct  labor  against  the  work  in  process,  and 
these  are  summarized  to  show  the  distribution  over  the  jobs 
in  process,  and  ultimately  the  total  direct  labor  charge 
against  each  job.  The  items  of  materials  and  supplies,  and 
labor  constitute  the  direct  charges. 

Overhead  comes  from  the  accounting  department,  and 
is  allocated  to  the  work  in  process  through  the  medium  of 
a  distribution  sheet,  showing  both  the  manufacturing  and 
general  overhead. 

The  results  of  the  charges  for 
Materials  and  supplies; 
Direct  labor; 
Overhead; 

Manufacturing; 
General, 

are  summarized  and  carried  in  the  cost  ledger  until  the  job 
is  completed.  At  such  time  they  are  transferred  to  a  finished 
goods  ledger. 

From  the  above  it  will  be  seen  that  the  books  required  in 
the  manufacturing  cost  system  are  three  (3),  namely: 
Materials  and  Supplies  Ledger; 
Cost  Ledger; 
Finished  Goods  Ledger. 

Specimen  pages  of  these  books  with  transactions  which 

21 


Principles  of  Cost  Accounting 

may  be  traced  from  the  various  reports  will  be  found  on 
pages  23,  24  and  25. 

The  reports  referred  to  are  three  in  number,  as  follows : 
Materials  and  Supplies — from  stores  department — 

see  page  23. 
Direct    Labor — from    operating    departments — see 

page  24. 
Overhead — from  accounting  department — see  page 

25- 

It  should  be  noted  that  the  three  books  comprising  a  part  of 
the  manufacturing  cost  system  are  controlled  by  accounts  in 
the  general  ledger  with  which  they  should  be  in  agreement. 
The  connection  between  the  books,  reports,  and  the  work 
as  it  passes  through  the  factory,  may  be  made  somewhat 
clearer  by  the  following  illustration : 


MATERIALS  & 
SUPPLIES 


DIRECT  LABOR 


COST  LEDGER 


FINISHED  GOODS 
LEDGER 


22 


The  Manufacturing  of  Factory  Cost  System 


HH  PQ 

g   ! 


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Amount 

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o 

in 

00 

8 

o 
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S 

o 

o 

£ 

55- 

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in 

C 

CO 

i 

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h      U 

,Q     'S 

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Principles  of  Cost  Accounting 


SPECIMEN  PAGE— COST  LEDGER 

Lot  Number  280 

Put  in  Process  Dec.  15-22.  Completed  Dec.  21-28 

Dozens  1224  Quality  #4  Cost  per  Dozen  $16.073341 


Date 

Total 

Materials 
and 
Supplies 

Labor 

Manufact- 
uring 
Overhead 

Overhead 
General 

Date 
Transferred 
to  Stock 

1908 

Dec.  10 

$7,311.28 

$7,311.28 

"      10 

924.23 

$924.23 

"     17 

1,540.39 

1,540.39 

"     24 

2,464.62 

2,464.62 

"     31 

1,232.33 

1,232.33 

"     31 

6,200.98 

$1,347.31 

$4,853.61 

$19,673.77 

$7,311.28 

$6,161.57 

$1,347.31 

$4,853.61 

Dec.  31/08 

24 


The  Manufacturing  of  Factory  Cost  System 


SPECIMEN  PAGE— FINISHED  GOODS  LEDGER 

Quality  94 
Production  Sales 


Date 

No. 
Lot 

No. 
of 
Doz. 

Cost 
Per 
Dozen 

Amount 

Date 

Inv. 
No. 

No. 
of 
Doz. 

Cost 
Per 
Dozen 

Amount 

1908 
Nov.  30 

268 

742 

$17.32 

$12,851.44 

1909 
Jan.    3 

73 

1000 

$17.32 

$12,851.44 

742 

Dec.  31 

280 

1224 

*16.07 

19,673.77 

258 

*16.07 

4,146.92 

"$16.073341 


CHAPTER  VI 
ORDERS 

Before  passing  on  to  the  detailed  discussion  of  the  ele- 
ments comprising  cost  and  the  methods  of  handling  same, 
some  attention  should  be  given  to  the  system  of  orders 
which  is  used  for  controlling  the  operation  of  the  plant  and 
the  goods  in  process. 

It  is  customary  to  allow  no  material  to  be  used  and  no 
labor  to  be  expended  without  an  order.  These  orders  origi- 
nate in  the  factory  office,  are  prepared  by  the  order  clerk, 
or  some  of  the  office-help,  and  are  always  authorized  by  the 
manager  or  superintendent,  or  someone  designated  by  the 
manager  with  the  authority  to  give  the  order;  never  by  the 
workmen. 

Orders  are  divided  into  three  classes,  which,  together 
with  their  uses,  are  shown  by  the  following: 

1.  Plant: 

(a)  Extensions. 

(b)  Equipment. 

(c)  Repairs  and  maintenance. 

2.  Production: 

(a)  Stock,  sometimes  called  standing  orders. 

(b)  Special,  specifications  accompanying. 
|(c)   Stock  repair. 

1.  Goods  damaged  before  shipment. 

2.  Goods  returned  by  customers. 

( a )  Repaired  at  plant's  expense. 

(b)  Repaired    at   customer's    ex- 

pense. 

3.  Shipping: 

26 


Orders 

It  may  not  seem  within  the  province  of  a  discussion  of 
cost  accounting  to  include  under  the  head  of  orders,  plant 
extensions,  equipment,  repairs  and  maintenance.  As  a  tech- 
nical matter  it  is  not,  since  cost  accounting  implies  such  ac- 
counting in  connection  with  the  product  manufactured.  The 
material  and  labor  incident  to  work  on  the  plant  are  often  so 
intimately  associated  with  such  items  entering  into  the  prod- 
uct and  the  principle  governing  their  control  so  identical, 
however,  that  it  does  not  seem  amiss  to  include  such  orders 
in  the  general  scheme  for  control. 

Materials  and  supplies  intended  for  plant  use  will  as  a 
rule  be,  or  should  be,  put  under  the  control  of  the  stores 
department  and  should  not  be  issued  without  the  proper 
order. 

Labor  on  plant  may  be  performed  by  some  of  the  oper- 
ating force  or  by  a  special  staff  consisting  of  carpenters,  ma- 
chinists, etc.,  engaged  for  such  purpose.  In  either  case  the 
orderly  and  systematic  record  of  the  work  requires  that  an 
order  for  same,  properly  describing  and  identifying  it,  shall 
be  issued. 

The  illustration  which  follows  is  intended  to  cover  the 
essential  features  of  such  an  order  without  attempt  at  polish. 


Principles  of  Cost  Accounting 

EMPIRE  HAT  MANUFACTURING  COMPANY 

f  Extensions.  -,. 

PLANT  ORDER: 1  Equipment. 

t  Maintenance  and  repairs.         Date 


SUPERINTENDENT  OR  FOREMAN: 

You  are  hereby  instructed  to  proceed  with  the  following  described 
work;  to  draw  on  the  stores  department  for  the  necessary  materials  and 
supplies  and  to  charge  all  labor  expended  in  connection  with  the  work  to 
the  above  order  number. 


DESCRIPTION  OF  WORK 


Manager. 

WORK  TO  BEGIN 

WORK  TO  BE  COMPLETED  . . 


ISSUED  IN  QUADRUPLICATE: 

i.  Office  or  order  department. 

a.  Factory. 

3.  Stores  department. 

4.  Cost  department. 

The  plan  of  manufacturing  differs  with  different  concerns 
and  in  accordance  with  the  peculiarities  of  the  different  lines 
of  business.  Some  concerns  manufacture  for  stock,  regard- 
less of  whether  or  not  sales  orders  have  been  received,  while 
others  begin  the  work  of  producing  on  special  orders  only 
after  sales  orders  have  been  received.  Other  concerns  do 
both. 

The  practice  will  depend  entirely  on  the  experience  of 
the  manufacturer  as  to  which  plan  shall  be  followed.  On 
staple  articles,  where  orders  are  large,  numerous,  and 
steady,  manufacturing  for  stock  will  usually  be  found,  since 

28 


Orders 

special  orders  would  delay  shipment  beyond  a  reasonable 
time.  In  lines  of  business  where  styles  play  an  important 
part  and  are  inclined  to  change  frequently  and  quickly  it 
would  be  taking  more  than  the  average  risk  to  produce  any 
considerable  amount  of  stock  in  advance. 

A  great  variety  of  production  order  forms  will  be  found 
in  practice,  framed  to  fit  the  needs  of  the  particular  cases, 
but  in  principle  they  are  represented  by  the  following: 
EMPIRE  HAT  MANUFACTURING  COMPANY 

f  Stock.  NQ 

PRODUCTION  ORDER:  .......  <  Special.  DATE 

(_  Stock  repairs. 


SUPERINTENDENT  OR  FOREMAN: 

You  are  hereby  instructed  to  proceed  with  the  production  of  the  follow- 
ing  described  articles;  to  draw  on  the  stores  department  for  the  necessary 
materials  and  supplies  and  to  charge  all  labor  expended  on  same  to  the  above 
order  number. 


WORK  TO  BEGIN 

GIVE  ORIGINAL  ORDER  NUMBER         __ 

IN  CASE  OF  STOCK  REPAIRS.  Manager. 

ISSUED  IN  QUADRUPLICATE: 

1.  Office  or  order  department. 

2.  Factory. 

3.  Stores  department. 

4.  Cost  department. 

The  principle  underlying  shipping  orders  is  that  all  fin- 
ished goods  shall  be  in  the  custody  of  the  stock  clerk  or  the 
shipping  clerk  and  that  nothing  shall  be  shipped  without  an 
order.  The  shipping  order,  when  completed  by  the  shipping 
clerk,  with  his  notation  to  the  effect  that  the  goods  have 
been  shipped,  is  returned  to  the  factory  or  general  office  and 
becomes  the  basis  for  preparing  the  sales  invoice  which  is 

sent  to  the  customer. 

29 


Principles  of  Cost  Accounting 

Provision  is  sometimes  made  for  connecting  the  shipping 
order  with  the  sales  invoice  by  a  manifold  process.  The 
shipping  order,  which  is  a  partially  completed  carbon  copy 
of  the  sales  invoice,  is  supplemented  after  being  taken  from 
the  billing  machine  with  such  information  as  is  needed  by  the 
shipping  clerk  but  does  not  concern  the  customer.  This 
scheme  where  practicable  has  the  advantage  of  reducing 
clerical  labor  somewhat. 

The  illustration  which  follows  shows  a  combination, 
shipping  order  and  sales  invoice.  The  two  carbon  copies 
which  go  to  the  shipping  clerk,  one  of  which  he  returns 
while  retaining  the  other  for  his  files,  contain  all  the  infor- 
mation shown  on  the  face  of  the  invoice  except  the  price  and 
amount.  These  are  prevented  from  being  copied  on  the 
carbons  by  shields. 


Date  Jan.  10,  1908 


John  C.  Brett  and  Company, 
712  7th  Ave.,  Pittsburgh,  Pa. 


TO  EMPIRE  HAT  MANUFACTURING  COMPANY, 
32  Waverly  Place,  New  York 


Invoice  No.  1 
Shipping  Order  No.  1 
Ship  at  once — prepaid 
Via  American  Express 


Pack  3  Doz.  to  the  Case 
Label  J.  C.  B.  &  Co. 


Date 


1908 
Jan.  9 


Qual. 


4xlw 
olw 


Style 


Bos.  Derby 
Stetson  2 


Color 


Brown 
Black 


Doz. 


Price 


$16.50 
14.00 


Less — Discount  10% 

Net 
1 


Amount 


$198.00 
84.00 


$282.00 
28.20 

$253.80 


SIZES 


7      7Ys 


CHAPTER  VII 

MATERIALS  AND  SUPPLIES 

Under  this  heading  four  things  should  be  considered: 

First :  A  place  to  keep  them. 

Second:  The  records  employed  by  the  stores  depart- 
ment. 

Third:   The  system  used  by  the  stores  department. 

Fourth:  Reports  issued  by  the  stores  department. 
With  regard  to  their  location  and  custody  it  is  of  course 
necessary  that  they  shall  be  under  the  immediate  supervision 
of  some  one  individual  who  will  be  responsible  for  their 
safety  and  preservation.  Such  an  individual  should  be  pro- 
vided with  the  proper  means  of  safeguarding  the  materials 
and  supplies,  as  it  is  absolutely  unjust  to  hold  a  man  respon- 
sible for  stores  without  providing  him  with  adequate 
physical  means  of  protecting  them. 

The  materials  and  supplies  of  like  nature  should  be  to- 
gether. They  should  be  arranged  in  an  orderly  manner  to 
the  end  that  they  may  be  easily  located  and  the  arrangement 
may  adapt  itself  to  the  taking  of  the  physical  inventory. 
Generally  speaking,  they  should  be  arranged  in  sections  or 
classes,  alphabetically,  or  in  the  order  that  the  accounts  ap- 
pear in  the  material  and  supplies  ledger  and  within  the  va- 
rious sections  they  should  be  arranged  in  racks,  tiers,  bins, 
closets  or  drawers,  depending  upon  their  nature. 

With  regard  to  records,  broadly  speaking,  it  is  desired 
to  know — 

31 


Principles  of  Cost  Accounting 

What  comes  in, 
What  goes  out, 
What  remains. 

The  record  in  each  instance  should  show  the  name  of  the 
materials  and  supplies,  the  class,  units,  price  per  unit  and 
cost.  The  original  record  of  what  comes  in  is  the  invoice. 
The  original  record  of  what  goes  out  is  the  requisition.  The 
ledger  should  show  what  remains. 

The  invoice  is  the  basis  for  taking  up  the  stock  by  the 
stores  clerk  and  constitutes  his  authority  for  so  doing.  In- 
voices are  usually  entered  in  a  book  of  record  in  order  to 
prevent  the  receipt  and  issue  of  stores  without  any  trace 
thereof  being  found.  Such  a  book  of  original  entry  is  also 
valuable  in  that  a  summary  of  the  cost  of  the  invoices  ob- 
tained therefrom  supplies  a  means  of  securing  a  general  or 
balancing  account  in  the  materials  and  supplies  ledger. 

The  requisition  is  the  authority  for  the  issue  of  materials 
and  supplies.  A  knowledge  of  what  it  should  recite  is  more 
essential  than  familiarity  with  some  particular  one  of  the 
various  forms  used.  It  should  first  of  all  receive  a  number; 
should  recite  the  number  of  units  required  and  give  an  accu- 
rate description  of  the  materials  and  supplies  to  be  issued; 
the  lot,  job  or  account  number  to  be  charged,  and  should 
bear  the  signature  of  some  person  in  authority.  It  is  not  the 
practice  to  insert  prices  on  requisitions  until  such  time  as 
the  materials  and  supplies  have  been  issued  unless  it  is  de- 
sired that  specific  materials  at  specific  prices  be  issued.  Or- 
dinarily, they  are  considered  as  issued  in  the  order  received, 
with  accompanying  prices.  A  summary  of  the  requisition  in 
a  book  of  record  is  desirable  especially  for  the  purpose  of 
supplying  totals  for  the  general  or  balancing  account  in  the 
materials  and  supplies  ledger. 

32 


Materials  and  Supplies 

The  ledger  should  contain  an  account  with  each  class  of 
materials  and  supplies  and  should  be  so  arranged  as  to  show 
the  details  of  receipts  and  issues,  setting  forth  in  the  case 
of  receipts ;  the 

Date 

Number  of  invoice  or  number  of  summary 

Units 

Price  per  unit 

Amount 
and  with  regard  to  issues;  the 

Date 

Number  of  requisition  or  number  of  summary 

Units 

Price  per  unit 

Amount. 

While  the  general  or  balancing  account  previously  re- 
ferred to  is  not  absolutely  necessary  since  the  materials  and 
supplies  ledger  is  controlled  by  the  materials  and  supplies 
account  in  the  general  ledger,  such  an  account  facilitates  the 
work  of  the  stores  department  in  that  it  is  relieved  of  the 
necessity  of  constantly  checking  with  the  controlling  account 
in  order  to  ascertain  if  the  ledger  is  in  balance.  The  form 
of  the  ledger  to  be  employed  is  largely  a  matter  of  choice. 
It  matters  little  whether  a  bound  book,  loose  leaf,  or  card 
system  is  used. 

The  operation  of  the  system  obtaining  in  the  stores  de- 
partment requires  that  as  to  invoices  they  shall  be  numbered 
consecutively  as  received  and  the  date  of  receipt  noted 
thereon.  Goods  and  prices  should  be  checked  and  extensions 
verified,  if  same  has  not  already  been  done.  The  invoice 
should  be  entered  on  the  invoice  record  for  summary  pur- 
poses and  the  details  of  the  invoice  posted  to  the  debit  of 

33 


Principles  of  Cost  Accounting 

the  appropriate  ledger  accounts.  Requisitions  should  have 
the  number  of  the  units  actually  issued  noted  thereon,  with 
prices  of  the  units  issued,  should  be  extended  and  entered  on 
the  summary  and  the  details  posted  to  the  credit  of  the  ap- 
propriate ledger  accounts. 

A  trial  balance  of  the  ledger  should  be  taken  monthly  or 
oftener.  The  continuous  posting  of  details  of  invoices  and 
requisitions  and  the  continuous  balancing  of  the  units  of 
stock  as  well  as  the  money  values,  proves  valuable  as  a  per- 
petual or  running  inventory.  The  balance  of  a  given  kind 
of  stock  as  shown  by  the  ledger  may  be  verified  by  checking 
with  the  physical  inventory,  at  regular  periods  or  at  such 
times  as  the  stock  is  at  a  minimum. 

One  report  only  is  necessary  from  the  stores  department 
so  far  as  the  cost  clerk  is  concerned  and  this  should  take  the 
form  of  a  summary  showing  particularly  the  cost  of  the  ma- 
terials and  supplies  issued  against  the  numbers  of  the  various 
jobs  in  process.  The  report  may  be  made  monthly,  bi- 
weekly, or  as  much  oftener  as  judgment  indicates  or  the  cost 
department  desires.  A  specimen  report  is  given  on  page  35. 

In  connection  with  the  general  discussion  of  materials 
and  supplies  a  few  words  should  be  said  regarding  freight 
and  cartage  and  labor  in  the  stores  department.  While  they 
will  be  discussed  here  from  a  strictly  technical  standpoint 
and  such  items  added  to  direct  cost,  experience  teaches  that 
while  perhaps  not  so  accurate  it  is  more  practicable  to  in- 
clude them  in  the  overhead. 

Inward  freight  may  be  added  to  the  price  per  unit  on  a 
percentage  basis  ascertained  by  finding  the  ratio  which  the 
freight  on  the  invoices  bears  to  the  cost  thereof.  Cartage 
unless  it  can  be  applied  to  specific  invoices  is  more  difficult  of 
distribution.  It  is  possible,  however,  to  ascertain  the  ratio 

34 


Materials  and  Supplies 

of  cartage  to  the  total  cost  of  goods  and  subsequently  dis- 
tribute same  over  the  invoices.  A  similar  ratio  of  the  cart- 
age to  the  cost  of  the  individual  invoices  may  be  ascertained 
and  the  cartage  then  applied  to  the  units.  This  method  is 


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35 


Principles  of  Cost  Accounting 

largely  based  on  theory  and  the  work  involved  frequently 
precludes  its  adoption  in  practice. 

Labor  in  the  stores  department  is  of  two  kinds : 
Manual. 
Clerical. 
Manual  labor  covers : 

(a)  Receiving  and  putting  goods  in  stock. 

(b)  Taking  goods  out  of  stock  and  preparing  them 

for  issue. 

It  will  be  seen  that  from  a  theoretical  standpoint  the 
manual  labor  involved  may  be  divided  between  the  two  pro- 
cesses just  mentioned,  and  that  it,  along  with  clerical  labor, 
may  be  distributed  over  the  invoices.  In  such  cases,  how- 
ever, the  invoices  would  have  to  be  held  until  the  end  of 
the  week  and  the  payroll  ascertained,  unless  the  labor  were 
to  be  distributed  daily.  An  arbitrary  percentage  is  some- 
times added  to  cover  this  and  other  factors,  but  the  objection 
to  this  plan  is  that  it  involves  an  adjustment  at  the  end  of  the 
week  or  month  in  order  to  bring  the  books  into  agreement 
with  the  actual  figures  which  the  payroll  shows.  The  prac- 
tice now  commonly  in  use,  is  to  throw  this  item,  like  inward 
freight  and  cartage,  into  the  overhead  for  general  distribu- 
tion. 


CHAPTER  VIII 
LABOR 

The  subject  of  labor  can  best  be  discussed  by  looking  at 
it  from  the  standpoint  of  the  foreman  or  head  of  a  depart- 
ment and  ascertaining  the  nature  and  extent  of  the  informa- 
tion he  requires. 

Labor  may  be  defined  as  services  performed  for  which 
compensation  is  paid.  The  compensation  may  take  the  form 
either  of  wages  or  salary,  and  labor  may  be  divided  into  two 
kinds,  clerical  and  manual.  Clerical,  or  administrative  labor, 
is  that  performed  with  the  head.  Manual  labor  is  that  per- 
formed with  the  hands.  Manual  labor,  in  turn,  so  far  as 
its  application  in  manufacturing  is  concerned,  may  be  divided 
into  direct  and  indirect  labor.  The  direct  labor  is  frequently 
referred  to  as  productive  labor,  and  the  indirect  as  non- 
productive labor.  A  choice  of  terms  in  this  matter  is  of 
slight  importance,  except  that  the  terms  direct  and  indirect 
appear  to  be  slightly  more  correct  from  a  descriptive  stand- 
point. It  is  usually  easier  to  determine  whether  or  not  an 
operative  is  directly  or  indirectly  engaged  upon  the  product 
than  whether  or  not  he  is  producing  anything.  The  direct 
labor  may  be  applied  either  to  the  work  performed  at  the 
hands  of  the  operatives  or  through  the  medium  of  machines. 
Such  labor  is  always  expended  in  connection  with,  but  not 
specifically  applied  upon,  the  product.  It  is  reasonable  to 
suppose,  looking  at  the  subject  from  the  standpoint  of  the 
foreman,  that  with  regard  to  the  work  of  the  individual  the 

37 


Principles  of  Cost  Accounting 

information  required  would  be  something  of  the  following 
nature : 

1.  What  the  operative  does;  the  nature  of  the  work  in 
which  he  is  engaged,  and  the  particular  job  upon  which  he  is 
working; 

2.  The  unit  of  compensation,  whether  it  be  on  a  time  or 
a  piece  or  job  basis;  if  on  the  time  basis,  whether  he  is  work- 
ing by  the  hour,  day,  week  or  month ;  if  on  a  piece  basis,  the 
number  of  units  produced;  if  on  a  job  basis,  the  amount  of 
time  employed  on  a  job; 

3.  The  rate  of  compensation; 

4.  The  amount  earned. 

What  applies  to  the  individual  applies  to  departments, 
and  in  order  to  obtain  the  same  information  with  regard  to 
the  departments  that  has  been  obtained  with  regard  to  in- 
dividuals it  is  only  necessary  to  multiply  the  information 
per  individual  by  the  number  of  individuals  in  the  depart- 
ment. 

What  applies  to  the  departments  applies  to  the  plant  as 
a  whole,  and  in  order  to  obtain  this  information  with  regard 
to  the  plant  as  a  whole  it  is  only  necessary  to  multiply  the 
departmental  information  by  the  number  of  departments. 
It  is  apparent  from  the  above  that  it  would  be  advisable  to 
have  a  summary  of  the  entire  plant,  showing 

1.  The  amount  earned  by  each  individual; 

2.  The  amount  of  work  of  the  operatives,  taken  collec- 
tively, which  applies  to  each  lot  or  job  or  class  of  work  in 
process. 

3.  The  total  amount  earned  by  all  operatives. 

As  to  the  reasons  for  recording  these  three  points  of  in- 
formation, it  may  be  said  that  with  regard  to  the  first  it  is 
necessary  to  ascertain  the  amount  of  the  payroll  liability  at 

38 


Labor 

the  end  of  each  period,  in  order  that  the  accounting  depart- 
ment, or  more  properly  speaking,  the  paymaster,  may  be 
informed  as  to  the  amount  necessary  to  meet  the  payroll; 
second,  the  liability  to  each  individual,  or  the  amount  which 
he  is  entitled  to  receive  at  the  hands  of  the  paymaster  on 
pay  day;  third,  for  the  purpose  of  distribution,  in  order  that 
the  amount  applicable  to  each  job  or  lot  may  be  ascertained. 
Having  determined  the  information  necessary,  the  matter 
of  records  may  now  be  considered.  These  will,  of  course, 
comprise  three  kinds;  those  pertaining  to  the  individual; 
those  pertaining  to  the  department;  those  pertaining  to  the 
plant  as  a  whole.  With  regard  to  those  of  the  department 
and  plant  as  a  whole,  it  is  unnecessary  to  say  scarcely  any- 
thing more  than  that  they  are  either  partial  or  complete 
summaries  of  the  individual  records.  The  record  of  the 
individual,  as  above  indicated,  should  show — 

1.  His  name  or  number; 

2.  The  nature  of  the  work  upon  which  he  is  engaged; 

3.  The  number  of  units  produced,  or  amount  of  work 
performed; 

4.  The  rate  of  compensation; 

5.  The  amount  earned. 

The  origin  of  the  individual  record  will  depend  largely 
upon — 

1.  The  nature  of  the  work; 

2.  The  intelligence  of  the  operative ; 

3.  The  basis  of  compensation. 

The  members  of  a  railroad  construction  gang  would  not, 
as  a  rule,  keep  their  own  records.  Laborers  in  a  foundry, 
on  account  of  the  low  order  of  intelligence  sometimes  obtain- 
ing, would  probably  not  keep  their  own  records,  whereas 
operatives  on  clothing,  being  of  a  higher  grade  and  em- 

39 


Principles  of  Cost  Accounting 

ployed  upon  piece  work,  might,  in  some  cases,  record  their 
own  work. 

The  form  to  be  employed  in  keeping  such  records  would 
depend  upon  the  type  of  production,  whether  single  or  mul- 
tiple unit,  and  the  basis  of  compensation,  whether  time  or 
piece. 

If  the  time  basis  were  in  use,  a  time  book  kept  by  the 
foreman  or  some  delegated  employee  might  be  used  for 
recording  day  labor. 

If  the  hour  were  the  unit  of  time,  it  is  more  probable 
that  the  time  would  be  recorded  upon  a  card,  which  might  be 
kept  by  the  operative  or  by  some  employee  designated  for 
this  work. 

In  cases  where  the  piece  basis  is  employed  for  the  re- 
cording of  work,  labor  tickets  are  commonly  used.  These 
are  either  given  out  to  employees  upon  the  completion  of 
work,  or  they  may  be  in  the  form  of  coupons  attached  to  an 
order,  which  are  detached  by  the  employee  when  the  job  is 
completed. 

Labor  tickets  may  also  be  arranged  so  that  they  may  be 
punched  by  the  foreman  or  some  designated  employee  when 
occasion  requires. 

In  the  first  of  the  two  instances  above  cited,  they  are  re- 
tained by  the  operatives  until  the  end  of  the  week  or  wage 
period,  when  they  are  turned  in  as  vouchers  and  made  the 
basis  upon  which  the  payroll  is  constructed.  The  labor  at- 
tendant upon  the  counting  of  coupons  is  sometimes  over- 
come by  issuing  them  in  strips  or  having  them  pasted  in 
books  something  on  the  same  order  as  those  issued  by  several 
well-known  concerns  who  give  trading  stamps  with  pur- 
chases. Rough  outlines,  indicating  in  a  general  way  the 
scheme  of  time  books,  cards,  and  labor  tickets  follow. 

40 


Labor 

TIME  BOOK— SINGLE  UNIT  PRODUCTION 
AND  DAY  LABOR 


Name 

M. 

T. 

W. 

T. 

F. 

S. 

Total 

Rate 

Amount 

TIME  CLOC 


TIME  CARD— MULTIPLE  UNIT 
AND  HOUR  BASIS 

NAME  OR  No. 


Job  No. 

In 

Out 

No.  Hours 

Rate 

Amount 

LABOR  TICKET 


Name  or  No. 


Job  No. 

Total 

Rate 

Amount 

Principles  of  Cost  Accounting 

In  connection  with  the  use  of  the  above  forms,  and  labor 
in  general,  calculating  machines  and  mechanical  devices  of 
all  kinds  are  invaluable  in  making  extensions  or  in  checking 
same  where  made  by  employees  or  foremen. 

No  matter  what  form  of  individual  record  is  used,  the 
information  therefrom  should  always  be  summarized,  on 
the  labor  reports,  so  as  to  show,  first,  by  departments,  and 


Zo 


MOOOO   COfO 


8O 
O 


«   rO  M   IO  fO  N   M 


42 


O 


Labor 

second,  by  a  subsequent  summary  of  these,  for  the  entire 
plant — 

1.  The  amount  of  the  pay  roll; 

2.  The  liability  to  each  operative; 

3.  The  distribution  of  labor. 

The  latter  information  should  be  so  arranged  that  the 
total  amount  applicable  to  each  job  may  be  seen  at  a  glance. 

The  summary  serves  two  purposes;  first,  that  of  supply- 
ing the  payroll  figures  to  the  accounting  department;  second, 
the  distribution  of  the  labor  to  the  cost  department.  A  speci- 
men labor  report  is  given  on  page  42. 


CHAPTER  IX 

OVERHEAD 

In  connection  with  this  topic,  the  question  may  well  be 
asked,  what  is  meant  by  overhead? 

The  term  in  itself  is  somewhat  difficult  to  define,  but  it 
should  convey  to  the  mind  the  idea  of  indirect  expense,  or 
everything  above  prime  cost;  the  expense  of  operating  the 
business,  not  only  of  the  plant,  but  the  entire  business;  the 
expense,  not  only  of  manufacturing,  but  selling,  administra- 
tion, and  carrying  on  the  business  in  general.  It  is  variously 
called  "Loading,"  "Burden,"  "Indirect  Expense,"  and  (es- 
pecially by  English  authorities)  "On  Cost." 

Overhead  divides  into : 
Manufacturing; 
General. 

Manufacturing  overhead  begins  with  indirect  labor  and 
ends  at  the  point  of  shipment  from  the  factory.  General 
overhead  begins  with  the  point  of  shipment  and  ends  at 
Profit  and  Loss  Surplus. 

It  should  be  borne  in  mind  that  manufacturing  overhead 
includes  not  only  the  miscellaneous  expenses  of  a  general 
nature  incident  to  the  manufacture,  but  in  practice  usually 
such  items  as  indirect  labor,  Inward  freight  and  cartage,  and 
minor  merchandise  and  supplies  which  are  inadaptable  to 
direct  distribution. 

General  overhead  has  nothing  whatever  to  do  with  the 
manufacturing.  It  covers  the  expenses  incident  to  the 

44 


Overhead 

conduct  of  the  business  from  the  point  where  the  goods  have 
been  finished  and  are  ready  to  be  shipped,  and  includes  such 
items  as  selling  expenses,  administrative  expenses,  deduc- 
tions from  income,  charges  for  reserves,  and  deductions 
from  sales. 

It  has  just  been  said  of  overhead  that  it  was  indirect  ex- 
pense. By  that  is  meant  expense  which  does  not  permit  of 
direct  distribution.  It  is  impossible  to  measure  the  propor- 
tion of  each  class  of  expense  which  is  applicable  to  each  job 
or  lot,  and  requires  some  kind  of  arbitrary  division  or  basis 
of  distribution. 

In  connection  with  a  discussion  of  bases,  the  following 
questions  are  pertinent: 

1.  Which  is  the  most  equitable? 

2.  Which  is  the  most  accurate? 

It  is  necessary  to  choose  some  basis  which  deals  fairly 
with  all  the  work  in  process ;  one  which  will  distribute  over- 
head to  all  jobs  in  actual  process,  and  avoid  loading  jobs 
which  are  in  the  factory,  but  not  in  process.  A  variety  of 
bases  is  available  from  which  to  choose.  They  divide  gen- 
erally into  five  classes,  namely: 

1.  Time; 

2.  Cost; 

3.  Percentage; 

4.  Production; 

5.  Sales. 

Under  the  time  basis  there  is  the  labor  hour,  the  machine 
hour,  and  the  overhead  day.  Under  the  cost  basis  there  is 
the  wage  hour  and  prime  cost. 

The  labor  hour  may  be  defined  as  the  unit  of  time 
whereby  the  work  of  one  operative  is  measured;  in  other 
words,  it  is  the  labor  of  one  operative  one  hour. 

45 


Principles  of  Cost  Accounting 

The  machine  hour  is  the  unit  of  time  whereby  the  work 
of  one  machine  is  measured;  it  is  the  work  of  one  machine 
one  hour. 

The  overhead  day  is  the  unit  of  time  whereby  the  amount 
of  overhead  applicable  to  each  unit  of  production  is  meas- 
ured; it  is  the  amount  of  overhead  applicable  to  one  unit 
during  the  period  of  one  day. 

As  a  concrete  example,  let  it  be  supposed  that  in  job  No. 
i  there  are  200  units  and  in  job  No.  2,  500  units.  The 
amount  of  overhead  for  the  period  to  be  distributed  is 
$2,000.  Let  it  be  assumed  that  job  No.  I  has  been  in  pro- 
cess 10  days  and  that  job  No.  2  has  been  in  process  4  days. 
It  will  be  apparent  that  job  No.  i,  consisting  of  200  units  in 
process  10  days,  would  be  equivalent  to  2,000  units  in  process 
one  day,  and  that  job  No.  2,  consisting  of  500  units  in  pro- 
cess 4  days,  would  be  equivalent  to  2,000  units  in  process  one 
day,  or  taking  the  work  collectively,  the  same  as  if  4,000 
units  had  been  in  process  one  day.  If  the  amount  of  over- 
head for  the  period  is  divided  by  4,000,  the  average  length 
of  time  the  units  collectively  have  been  in  process,  a  rate  of 
50  cents  will  be  obtained,  which  may  be  made  the  basis  for 
distributing  the  overhead  as  between  the  two  jobs,  in  accord- 
ance with  the  number  of  overhead  days  involved,  which  in 
this  particular  example  happens  to  be  2,000  in  each  case. 
Having  allocated  the  overhead  to  jobs,  it  is  a  simple  opera- 
tion to  reapportion  it  to  units  by  dividing  the  overhead  on 
each  job  by  the  number  of  units  involved,  respectively.  The 
amount  of  overhead  applicable  to  each  job  is  $1,000.  Job 
No.  i  involving  200  units  will,  therefore,  bear  a  cost  over- 
head of  $5.00  per  unit,  while  Job  No.  2  with  500  units  will 
cost  with  regard  to  overhead  $2.00  per  unit. 

As  stated  above,  under  the  cost  basis,  there  is  the  wage 

46 


Overhead 

hour  and  prime  cost  from  which  to  select.  Prime  cost  needs 
no  discussion,  except  to  refresh  the  reader's  memory  that  it 
includes  but  two  items,  materials  and  supplies,  and  direct 
labor. 

The  wage  hour  may  be  defined  as  the  unit  of  cost, 
whereby  the  work  of  an  operative  is  measured.  It  is  the 
cost  of  the  work  of  one  operative  for  one  hour. 

Of  the  other  bases  of  distribution  little  needs  to  be  said. 
Students  of  the  subject  of  cost  accounting  generally  are 
familiar  with  the  percentage  basis,  and  it  is  only  necessary  to 
make  mention  of  the  fact  that  the  amount  of  overhead  ap- 
plicable to  each  job  is  that  proportion  which  the  number  of 
units  in  the  job  bears  to  the  total  number  of  units  involved. 

In  the  case  of  the  production  basis  the  number  of  units 
involved  would  be  the  number  produced,  and  in  the  case  of 
sales  the  number  sold. 

The  sales  basis  is  not  so  frequently  used  in  manufactur- 
ing concerns  as  it  is  in  wholesale  and  retail  concerns  organ- 
ized on  a  departmental  basis,  and  where  the  distribution  of 
general  expense  is  thought  to  be  more  accurately  made  by 
using  the  volume  of  sales  of  the  respective  departments  as  a 
basis. 

It  has  not  been  thought  necessary  to  give  the  formula 
for  distributing  the  overhead  under  each  basis,  since  it  may 
be  easily  deduced  from  the  illustration  covering  the  over- 
head day. 

The  bases  in  all  cases  depend  upon  circumstances.  They 
will  be  governed  many  times  by  whether  the  employees  are 
paid  by  the  day  or  hour,  or  by  the  piece;  they  will  be  gov- 
erned by  the  nature  of  the  business.  A  time  basis  would  not 
ordinarily  be  employed  in  cases  where  goods  are  required 
to  be  invoiced  before  the  records  are  completed,  or  the  end 


Principles  of  Cost  Accounting 

of  the  month  is  reached.  A  job  printing  establishment,  for 
instance,  usually  does  work  on  an  estimated  basis  and  bills 
the  job  as  soon  as  completed,  adding  to  the  prime  cost  an 
arbitrary  percentage  to  cover  the  overhead  and  profit. 

The  basis  to  be  employed  may  also  depend  upon  the  fa- 
cility or  regularity  with  which  the  books  can  be  closed. 

While  it  is  impossible  to  make  any  hard  and  fast  rule  as 
to  the  basis  to  be  employed,  such  a  division  being  entirely 
governed  by  circumstances,  there  is  this  to  be  said:  the  time 
basis  is  the  ideal,  and  always  preferable.  No  other  basis 
should  be  considered  if  a  time  basis  can  be  used.  The  argu- 
ment in  its  favor  is  that  practically  all  the  items  entering 
into  the  overhead  are  of  such  nature  that  they  accrue  over 
a  period  of  time.  Examples  of  these,  which,  upon  an- 
alysis, will  be  found  to  bear  out  the  above  statement,  are  as 
follows : 

Heat,  Traveling  expenses, 

Light,  Advertising, 

Power,  Salaries  of  officers, 

Direct  labor,  Rent, 

Salaries,  manager  and  clerks,  Taxes, 

Depreciation  of  equipment,  Insurance, 

Salaries  of  salesmen,  Interest. 

Having  selected  the  time  basis,  there  is  the  choice  of  the 
labor  hour,  the  machine  hour,  and  the  overhead  day,  depend- 
ing upon  the  payment  of  compensation,  whether  the  unit  be 
one  of  time  or  piece. 

The  arguments  against  the  wage  hour,  prime  cost  and 
percentage  bases  are  as  follows : 

It  is  claimed  that  where  the  wage  hour  is  employed  the 
burden  falls  on  the  high-priced  labor,  which  is  unjust.  The 

48 


Overhead 


skilled  workman  is  usually  more  rapid,  turns  out  more  and 
better  work,  and  requires  less  supervision.  In  the  case  of 
prime  cost  the  burden  falls  upon  the  expensive  material, 
while,  as  a  matter  of  fact,  the  expensive  product  takes  no 
longer  to  go  through  the  factory  than  the  inexpensive  one. 
The  objection  to  the  percentage  basis  is  that  at  best  it  is 
only  an  estimate  based  on  past  experience.  It  is  constantly 
changing  and  should  be  constantly  revised. 

Irrespective  of  the  basis  selected,  the  overhead  should 
be  summarized  on  the  overhead  report  in  order  that  the  cost 
department  may  make  the  distribution  to  the  various  jobs. 
A  specimen  report  is  given  as  follows : 


DISTRIBUTION  OF  MANUFACTURING  AND  GENERAL  OVERHEAD  FOR  THE 
MONTH  ENDED  DECEMBER  31,  1908 


. 

en 

c 

B, 

jj 

§ 

rt 

AVERAGE  COST  PER 

6 
2 

£ 

H 
0 

G 

Q 

Tl 

OVERHEAD  DAY 

Total 

Manufac- 

Genera' 

o 

B 
E 

"3 

S 
B 

Manutac- 

General 

Overhead 

turing 

>•» 

rt 

a 

d 

O 

turirg 
Overhead 

Overhead 

274 

2 

74 

148 

.157248 

.566481 

$107.11 

$23.27 

$83.84 

275 

2 

68 

136 

98.43 

.21.39 

77.04 

276 

2 

50 

100 

72.37 

15.72 

56.65 

277 

2 

55 

110 

79.62 

17.30 

62.32 

278 

5 

873 

4365 

3,159.08 

686,39 

2,472.69 

279 

S 

1437 

11496 

8,320.00 

1,807.73 

6,512.27 

280 

7 

1224 

8568 

6,200.92 

1,347.31 

4,853.61 

281 

2 

1464 

2928 

2,119.09 

460.43 

1,658.66 

Total    . 

27851 

$20,156.62 

$4,379.54 

$15,777.08 

Total  Over- 
head 

Total  Over- 
head Days 

Average  Cost 
per  Overhead 
Day 

Manufacturing   Overhead           

$  4,379.54 

27851 

157248 

General  Overhead                         

15,777.08 

27851 

566481 

Total  

$20,156.62 

27851 

.723729 

49 


CHAPTER  X 

TYPES  OF  MANUFACTURING  COST  SYSTEMS 

Manufacturing  cost  systems  differ  as  to  type.  Accord- 
ingly, they  may  be  classified  as  simple,  compound,  and  com- 
plex. The  type  depends  upon  such  things  as  whether  the 
goods  are  produced  on  special  or  stock  order  or  whether  the 
work  is  performed  by  hand  or  machine,  and  the  peculiarities 
of  the  business,  such  as  necessity  for  rendering  invoices  at 
the  time  of  delivering  work,  for  example. 

All  types  involve  the  same  elements — materials  and  sup- 
plies, labor  and  overhead.  The  first  two,  in  so  far  as  their 
relation  to  the  type  of  system  is  concerned,  do  not  vary. 
The  last  named  should  be  classified  for  the  reason  that  it  is 
comprised  of  items  of  two  different  kinds ;  those  which  per- 
mit of  distribution  to  the  operating  departments  and  those 
which  do  not.  A  part  of  the  overhead  originates  in  the  de- 
partments and  must  be  applied  to  the  product  through  such 
channels.  Some  of  the  overhead  is  foreign  to  the  depart- 
ments both  in  its  origin  and  application,  and  while  it  must 
be  applied  to  the  product,  it  never  reaches  it  by  way  of  the 
operating  departments.  Overhead  in  its  relation  to  the  oper- 
ating departments  as  affecting  the  different  types  of  system 
is  therefore  classified  as  distributable  and  non-distributable. 

In  the  simple  type  all  of  the  three  elements  go  through 
the  factory,  without  combination,  direct  to  the  product.  The 
word  "combination"  is  used  here  as  referring  to  the  elements 
from  an  accounting  standpoint  rather  than  a  physical  stand- 


Types  of  Manufacturing  Cost  Systems 

point.  In  the  compound  type,  material  may  go  direct,  while 
the  labor  and  distributable  overhead  become  combined  or 
material  and  labor  may  be  combined  while  distributable  over- 
head goes  direct.  In  the  complex  type,  material,  labor  and 
distributable  overhead  become  combined,  while  the  non-dis- 
tributable goes  direct. 

These  combinations  may  represent  departments,  proc- 
esses, machines,  or  centers  of  production.  There  is  no  great 
distinction  between  "department"  and  "process"  as  used 
herein,  except  that  more  than  one  process  may  be  included 
in  one  physical  department. 


In  the  accompanying  illustrations,  where  an  attempt  is 
made  to  bring  out  more  clearly  the  subject  matter  of  the 
preceding  paragraphs,  departments  are  indicated  by  the  let- 
ters— A — B — C ;  the  elements  of  cost  by  the  letters,  M,  L, 
O — D,  and  O,  N — D;  and  the  jobs  by  numbers. 

Words  and  graphics  almost  fail  when  an  attempt  is  made 
to  describe  briefly  and  clearly,  or  to  illustrate,  the  complex 
type  of  cost  system.  It  may  be  referred  to  as  a  group  of 
small  cost  systems  wherein  each  operating  department  con- 


Principles  of  Cost  Accounting 

stitutes  a  member.  It  might  aid  in  the  illustration  if,  in  the 
diagram  illustrating  the  complex  type,  one  were  able  to  im- 
agine the  departments  "A — B — C"  as  containing  within  their 
respective  limits  the  diagram  of  the  simple  type  sufficiently 
reduced  in  size  to  permit  of  such  treatment. 


In  the  operation  of  the  complex  system,  materials  and 
labor  may  be  combined  within  a  given  department  and  car- 
ried forward,  or  the  combination  may  be  extended  to  in- 
clude all  of  the  three  elements  and  similar  treatment  follow. 
The  last  named  procedure  is  difficult  of  accomplishment, 
except  where  conditions  have  been  standardized  and  an  over- 
head rate  can  be  ascertained.  The  difficulties  in  the  way  of 
success  in  the  absence  of  such  a  rate  are  as  follows : 

1.  The  cost  record  must  follow  the  product. 

2.  The  distribution  cannot  be  made  until  the  end  of  the 
month  or  period. 


M 


Types  of  Manufacturing  Cost  Systems 

COMPLEX  TYPE 


TO  JOBS 


3.  The  product  must  go  forward  when  required  for 
physical  treatment,  irrespective  of  the  cost  record. 

Whether  or  not  the  rate  is  correct  cannot  be  determined 
until  the  end  of  the  period,  when  the  actual  amount  of  over- 
head for  the  period  has  been  ascertained  and  the  true  rate 
found. 


53 


CHAPTER  XI 

WHEN  DEPARTMENTAL  DISTRIBUTION  OF  OVERHEAD  is 

INDICATED 

Since  the  time  when  Adam  Smith  advanced  and  substan- 
tiated the  theory  that  a  division  of  labor  increases  produc- 
tion, the  tendency  on  the  part  of  the  manufacturer  toward  a 
highly  developed  physical  organization  has  been  constantly 
increasing.  Manufacturers  have  learned  that  by  segregating 
and  controlling  their  materials  and  supplies  and  dividing  the 
operatives  into  departmental  groups,  increased  production 
and  greater  efficiency  result.  Arranging  the  departments  so 
that  the  course  of  the  product  is  ever  forward,  results  in  a 
great  saving  of  time  and  a  corresponding  increase  in  the 
amount  of  work  of  which  the  organization  is  capable.  In 
the  more  modern  plants  special  attention  has  been  given  to 
the  physical  arrangement  of  the  various  departments.  The 
stores  department  where  the  incoming  material  is  received 
is  located  as  near  as  possible,  not  only  to  the  department 
where  the  first  operation  of  labor  is  performed,  but  to  the 
means  of  transportation,  whereby  the  material  is  received. 
The  course  of  work  is  constantly  forward,  never  doubling 
back  or  going  twice  over  the  same  route,  and  finally  reaching 
the  shipping  department  which  is  located  adjacent  to  the 
shipping  facilities.  The  effect  which  such  an  organization 
has  upon  the  elements  of  cost  is  decidedly  simple  except  in 
the  case  of  overhead.  The  materials  and  supplies  present 
no  particular  problem,  since  in  no  matter  which  type  of  sys- 

54 


When  Departmental  Distribution  of  Overhead  is  Indicated 

tern  is  involved,  they  emanate  either  from  the  main  stores,  or 
what  might  be  termed  branches  of  the  main  stores  located 
in  the  departments  and  known  as  department  stores.  The 
direct  labor  originates  in  the  various  departments  and  causes 
no  particular  trouble  in  its  handling.  The  treatment  of  the 
overhead  is  the  problem  which  is  hardest  to  deal  with. 
While  the  statement  has  been  made  heretofore  that  it  was 
inadvisable  in  the  simple  type  of  system  to  distribute  the 
overhead  to  departments,  and  subsequently  apply  it  to  the 
product,  it  must  be  borne  in  mind  that  in  the  compound  and 
complex  type  the  situation  is  entirely  different.  These  types 
frequently  have  to  provide  for  complex  and  diversified 
product,  and  in  such  instances  a  departmental  distribution 
of  the  overhead  is  not  only  desirable  for  statistical  purposes, 
but  absolutely  necessary  in  order  to  obtain  results  which 
most  nearly  approach  correctness. 

In  the  case  of  diversified  product  certain  units  go  through 
all  departments,  certain  units  go  through  a  part  only  of  the 
departments,  and  in  either  instance  certain  units  may  go  into 
departments  where  the  overhead  varies  from  heavy  to  light. 
It  would  be  manifestly  unfair  to  charge  the  product  with 
overhead  of  departments  through  which  it  has  not  passed, 
or  to  burden  product  going  through  departments  wherein  it 
is  heavy.  Where  a  variation  of  the  overhead  exists  it  is 
unquestionably  more  correct  to  localize  and  apply  it  to  the 
product  at  points  of  contact.  The  justice  of  so  doing  is 
shown  by  the  illustrations  wherein  the  local  and  general 
methods  are  compared  on  page  56. 

In  the  following  tabulation  "light"  is  the  item  which  has 
been  selected  for  distribution.  The  total  cost  of  the  light 
for  the  period  was  $24,  used  in  the  various  departments, 
designated  A,  B,  C  as  indicated.  It  is  assumed  that  job  No. 

55 


Principles  of  Cost  Accounting 

i  was  34  hours,  and  job  No.  2,  u  hours  in  going  through 
the  three  departments  as  indicated  in  the  tabulation.  By  dis- 
tributing the  overhead  to  the  respective  jobs  from  depart- 
ments, it  is  apparent  that  job  No.  i  would  bear  $18.40  and 
job  No.  2,  $5.60;  as  against  the  respective  amounts  $18.13 

Departments 


Total 


B 


Light $24.00        $10.00  $8.00          $6.00 

Job  No.  i 34  hours       8  hours  16  hours     10  hours 

"        "     2 II      "                2      "  4      "                5      " 

45  hours      10  hours  20  hours      15  hours 

Departmental  Distribution 
Job  No.  i Job  No.  t 

A $8 .  oo  $2 .  oo 

B 6 . 40  i .  60 

C 4.00  2.00 

$18.40  $5.60 

General  Distribution 

No.  i  No.  2 

ATT 

B 

C.. 


45)$24.oo 

•  5333 
34 

21332 
15999 

$18.1322 


•5333 


II 

5333 
5533 

$5-8663 


and  $5.87,  were  the  overhead  to  be  apportioned  on  the  basis 
of  total  hours  without  regard  to  the  amount  of  time  spent 
in  the  respective  departments. 

It  has  been  previously  stated  that  one  of  the  principal 

56 


X 
When  Departmental  Distribution  of  Overhead  is  Indicated 

objects  of  departmental  distribution  was  to  secure  statistical 
information.  Such  information  is  needed  for  administrative 
purposes  and  affords  an  opportunity  for  comparison  which 
is  invaluable.  It  may  be  made  to  serve  as  an  index  to  effi- 
ciency. By  distributing  to  the  centers  of  production,  such  as 
departments,  processes,  or  men,  the  items  of  expense  or  cost 
affecting  such  centers,  and  redistributing  in  turn  to  the  units 
of  product  undergoing  process  the  expense  or  cost  thus  con- 
nected, the  establishment  of  a  rate  or  amount  per  unit  is 
made  possible,  which  furnishes  a  ready  means  of  comparison 
and  indicates  the  capability  of  the  operating  center  involved. 
In  like  manner  items  of  cost  may  be  grouped  around  ma- 
chines so  as  to  produce  similar  results.  The  obtaining  of 
rates  has  the  effect  of  creating  standards,  while  perhaps  not 
standards  in  the  scientific  sense,  at  least  temporary  standards 
which  measure  capacity  and  ability  for  work  and  answer 
that  purpose  until  replaced.  In  this  way  they  serve  as  an 
index  to  efficiency.  Through  the  means  of  such  statistics  it 
may  become  evident  that  the  increased  cost  of  a  certain  pro- 
cess is  due  to  the  idle  time  or  inefficiency  on  the  part  of  the 
operatives.  This  may  have  occurred  on  account  of  a  falling 
off  in  the  amount  of  work,  some  fault  in  the  method  of  dis- 
tributing work,  or  delay  on  the  part  of  the  foreman  in  so 
doing.  Proper  statistics  can  be  made  to  indicate  such  condi- 
tions promptly,  thus  paving  the  way  to  the  application  of 
remedies.  Such  remedies  may  be  brought  about,  first,  on 
the  part  of  the  foreman,  by  laying  off  a  part  of  the  force,  or 
improving  the  method  of  distributing  work;  second,  on  the 
part  of  the  superintendent  in  causing  the  foreman  to  become 
more  efficient,  either  through  the  aid  of  advice,  or  such  other 
measures  as  may  suggest  themselves  in  view  of  the  circum- 
stances surrounding  the  case. 

57 


CHAPTER  XII 

DEFECTIVE  GOODS,  WASTE,  SHRINKAGE  AND  IDLE  TIME 

Incident  to  the  processes  of  production  there  frequently 
occur  certain  irregularities  which  complicate  the  problem  of 
obtaining  accurate  costs. 

In  the  casting  of  soil  pipe  and  fittings,  air  bubbles  and 
failure  of  the  molten  metal  to  run  evenly  cause  many  defec- 
tive pieces.  In  the  cutting  of  half-soles  out  of  sides  of 
leather  there  is  waste.  In  the  importation,  roasting  and 
packing  of  coffee  there  is  loss  through  shrinkage.  In  the 
case  of  operatives  paid  by  the  hour  there  will  be  time  be- 
tween jobs  which  will  be  lost.  Hence,  several  somewhat 
knotty  problems  present  themselves  in  the  form  of  the  treat- 
ment of  defective  goods,  waste,  shrinkage  and  idle  time. 

With  regard  to  defective  goods  there  are  three  methods 
available.  The  first  is  to  divide  the  cost  of  the  job  or  lot  by 
the  number  of  perfect  units,  thereby  buying,  in  the  cost  of 
the  perfect  units,  the  cost  of  the  defective  work.  The  second 
way  is  to  divide  the  cost  of  the  entire  lot  or  job  by  the  num- 
ber of  the  perfect  units,  after  deducting  the  cost  or  scrap 
value  of  the  defective  work.  The  third  way  is  to  set  up  the 
defective  work  at  its  actual  cost  and  carry  it  through  as  de- 
fective work,  adding  to  the  first  cost  any  subsequent  cost  ap- 
plicable thereto.  As  an  illustration  of  the  first  method, 
assuming  the  cost  of  producing  100  perfect  units  to  be  $500 
— it  is  evident  that  if  only  98  perfect  units  result  the  cost  will 
be  $5.10  per  unit.  In  the  case  of  the  second  method,  the 

58 


Detective  Goods,  Waste,  Shrinkage  and  Idle  Time 

cost  will  be  $5.06,  if  it  is  assumed  that  $4,  being  the  scrap 
value  of  the  imperfect  units,  has  been  deducted  from  the 
cost  of  the  lot,  and  the  balance  of  $496  divided  by  98  per- 
fect units.  In  the  case  of  the  third  method,  the  cost  per  unit 
will  be  $5 — 98  being  perfect  and  2  imperfect.  The  second 
method  is  probably  the  most  common. 

One  of  the  collaborators  on  "a  uniform  method  of  cost- 
finding  for  steel  foundries"  has,  in  effect,  this  to  say  on  the 
subj  ect : 

"Defective  castings  fall  naturally  into  two  divisions. 
First,  those  discarded  at  the  foundry  as  imperfect,  and  sec- 
ond, those  returned  by  customers.  The  reason  for  discard 
at  the  foundry  may  be  either  on  account  of  construction,  due 
to  the  complication  of  pattern  or  thinness  of  section,  or  im- 
perfect practice.  In  such  cases  the  job  should  be  charged 
with  the  material,  and  labor  credited  with  metal  at  scrap 
value,  and  the  balance  divided  by  the  number  of  good  cast- 
ings. As  a  prevention  against  the  return  of  defective  cast- 
ings by  customers,  the  cost  should  be  loaded  with  an  arbi- 
trary percentage  based  on  the  cost  less  the  scrap  value  which 
should  be  credited  to  the  proper  reserve." 

In  the  manufacture  of  hats,  for  example,  the  third 
method,  while  perhaps  not  most  commonly  used,  is  the  most 
scientific.  Defective  hats  are  known  as  "knock-downs." 
The  cost  of  "knock-downs"  is  of  considerable  importance. 
The  question  presented  is,  whether  or  not  it  pays  to  finish 
up  for  sale  hats  which  are  imperfect  when  formed.  Is  it 
good  practice  to  load  the  cost  of  "knock-downs"  up  to  the 
point  of  "stock  bodies,"  on  perfect  hats,  and  finish  up  for 
sale  a  hat,  the  proceeds  from  the  sale  of  which  is  considered 
as  so  much  "velvet?"  As  a  result  of  such  practice  "knock- 
downs" might  very  easily  be  sold  at  a  considerable  loss,. 

59 


Principles  of  Cost  Accounting 

whereas,  if  the  proper  information  were  available,  the  super- 
intendent would  be  enabled  to  decide  whether  or  not  imper- 
fect bodies  might  be  profitably  completed. 

Waste  and  shrinkage  seem  to  present  similar  characteris- 
tics and  would  seem  to  be  subject  to  the  same  treatment  if 
it  were  not  for  the  fact  that  in  the  case  of  waste  something 
may  be  recovered  from  the  scrap,  whereas  shrinkage  leaves 
nothing  behind  which  may  be  realized  upon. 

To  illustrate  by  a  theoretical  example  the  treatment  of 
waste,  let  it  be  assumed  that  a  side  of  leather  2*4x3*4  ft 
square,  containing  1053  square  inches,  costs  $4.21.  If  a 
pair  of  soles  averages  80  square  inches  and  out  of  the  side, 
allowing  for  the  irregular  edges,  twelve  pairs  of  soles  rep- 
resenting 960  square  inches  can  be  cut,  the  remaining  93 
square  inches  will  be  waste.  Expressed  in  dollars  and  cents, 
the  situation  will  be  as  follows:  cost  of  12  pairs  of  soles, 
$3.84,  or  32  cents  per  pair;  waste,  37  cents;  total,  $4.21. 

The  waste  may  be  treated  in  three  ways,  namely,  charged 
to  profit  and  loss ;  given  a  scrap  value  and  deducted  from  the 
cost  of  the  side;  or  loaded  onto  the  cost  of  the  12  pairs  of 
soles. 

The  first  treatment  is  not  desirable.  The  second  is  not 
practicable,  since  while  the  pieces  will  doubtless  be  used  up 
it  is  not  possible  to  assign  a  value  to  them.  The  third 
method  seems  preferable  and  will  increase  the  cost  per  pair 
to  35  cents. 

Shrinkage  involves  no  question  of  scrap  value.  It  repre- 
sents the  invisible  disappearance  of  weight  through  evapo- 
ration. It  may  be  treated  in  two  ways,  viz.,  charged  to  profit 
and  loss  or  made  to  increase  the  cost  of  the  product  that 
remains.  The  latter  is  preferable. 

Suppose  that  a  merchant  were  to  purchase  a  bale  of  to- 

60 


X 
Defective  Goods,  Waste,  Shrinkage  and  Idle  Time 

bacco  weighing  200  pounds  for  $194.  The  cost  would  be  97 
cents  per  pound.  If  at  the  time  of  sale  at  $1.10  per  pound 
the  contents  of  the  bale  have  shrunk  to  194  the  cost  per 
pound  will  have  increased  to  $1.00.  The  theoretical  ques- 
tion now  presented  is — "Has  the  merchant  sold  194  pounds 
of  tobacco  at  97  cents  per  pound  and  made  a  profit  of  $31.82 
or  194  pounds  at  $1.00  per  pound  and  realized  a  profit  of 
$26.00"?  Obviously,  the  net  result  is  the  same  in  either 
case,  since  if  the  first  method  of  handling  the  transaction  is 
selected  the  gross  profit  of  $31.82  will  be  offset  in  the  profit 
and  loss  account  by  the  loss  on  6  pounds  of  shrinkage  at  97 
cents,  or  $5.82.  While  either  method  may  be  said  to  be 
correct,  the  second  is  to  be  preferred,  under  ordinary  cir- 
cumstances, since  it  facilitates  the  work  of  the  cost  depart- 
ment and  leaves  no  profit  and  loss  adjustment  to  be  taken 
into  consideration. 

Idle  time  affects  the  costs  in  the  same  manner  as  shrink- 
age. If  a  man  is  paid  $2.40  for  an  eight-hour  day  and  works 
only  6  hours  the  result  is  a  cost  per  hour  of  40  cents  per 
hour  instead  of  30  cents.  If  his  time  is  being  charged  against 
a  piece  of  work  it  is  apparent  that  it  must  be  charged  at  40 
cents  instead  of  30  cents  unless  it  is  desired  to  charge  2  hours 
of  his  time  at  30  cents  an  hour  to  profit  and  loss. 

Loss  of  time  between  jobs  has  the  same  effect,  although 
as  a  practical  matter  many  concerns  now  employ  time  clocks 
where  the  finishing  time  on  one  job  and  the  starting  time  on 
the  succeeding  job  are  simultaneously  recorded. 

What  is  sometimes  called  "a  profit  on  labor"  is  merely 
a  percentage  added  to  the  hourly  rate  paid  to  the  operative 
which  experience  shows  to  be  necessary  in  order  to  provide 
for  the  idle  time  incident  to  break-downs  and  delays  of  one 
kind  or  another. 

61 


Principles  of  Cost  Accounting 

Idle  time  will  ordinarily  be  charged  to  cost  of  production, 
but  where  abnormally  extended  as  in  the  case  of  certain  op- 
eratives paid  during  a  strike  or  other  periods  of  enforced 
idleness  the  time  should  be  charged  to  profit  and  loss. 

The  same  thing  may  be  said  of  defective  goods,  waste 
and  shrinkage,  that  while  ordinarily  the  cost  of  production 
should  be  loaded  to  provide  for  such  loss,  under  abnormal 
circumstances  such,  for  example,  as  damage  to  raw  material 
by  water,  the  loss  should  be  charged  off. 

A  general  rule  with  regard  to  these  items  may  therefore 
be  formulated  as  follows: 

Where  the  loss  is  incident  to  the  production  it  should  be 
charged  to  cost.  Where  the  loss  is  an  extraordinary  one  and 
not  connected  with  the  production  the  loss  should  be  charged 
to  profit  and  loss. 


62 


CHAPTER  XIII 

DISTRIBUTABLE   OVERHEAD  AND   THE   BASES   OF 
DISTRIBUTION 

In  making  the  distribution  of  such  overhead  as  permits 
of  distribution  to  the  various  departments,  care  should  be 
taken  that  only  such  overhead  be  distributed  to  the  respective 
departments  as  distinctly  applies  to  them.  Such  overhead  as 
applies  must  be  analyzed  and  some  consideration  given  to 
the  departments  as  to  their  physical  characteristics,  the  ca- 
pacity of  their  contents,  and  frequently  the  value  of  same. 
In  this  connection  there  must  be  considered  the  floor  space, 
cubic  contents,  value  of  the  machinery  and  the  horse-power 
of  same. 

It  is  probable  that  before  proceeding  to  the  discussion  of 
the  items  to  be  distributed  some  thought  should  be  given 
to  certain  of  these  items  as  to  the  economic  and  other  theo- 
ries concerning  them.  Reference  is  made  especially  to  rent, 
taxes,  insurance,  and  interest  on  capital  invested  in  machinery 
and  tools. 

Under  the  economic  theory,  these  items  are  not  consid- 
ered as  a  part  of  the  manufacturing  overhead.  Under  cer- 
tain popular  theories  advanced  by  engineers  and  accountants, 
these  items  play  a  most  important  part.  The  economist,  and 
the  accountant  who  endeavors  to  base  his  accounting  on  a 
substantial  economic  foundation,  argues  that  rent  plays  no 
part  in  the  manufacturing  cost.  It  is  an  item  of  general 
overhead,  to  be  taken  into  consideration  in  fixing  the  selling 

63 


Principles  of  Cost  Accounting 

price,  but  from  the  standpoint  of  the  business,  taken  as  a 
whole,  is  a  deduction  from  income,  and  no  part  of  manufac- 
turing costs.  It  is  probable  that  before  this  question  can  be 
satisfactorily  settled,  considerable  research  on  the  part  of 
men  possessing  the  necessary  qualifications  will  be  necessary. 
It  has  in  its  favor,  that  its  exclusion  from  manufacturing  cost 
facilitates  comparison  where  some  concerns  own  their  build- 
ings, while  others  are  obliged  from  their  lack  of  capital  to 
share  a  portion  of  their  income  with  the  landlord. 

It  will  be  pointed  out  by  the  opposers  of  this  theory  that 
a  concern  purporting  to  own  its  own  plant  may  be,  in  fact, 
paying  interest  on  capital  borrowed  for  the  purpose.  It  will 
further  be  pointed  out  by  such  persons  that  even  though  this 
were  an  investment  of  owned  capital,  taxes  are  paid  on  the 
property  in  lieu  of  rent  and  interest.  This  contention  may 
be  met  by  the  supporters  of  the  economic  theory  with  the 
statement  that  there  is  not  a  sufficient  similarity  in  amount  as 
among  these  three  items  to  permit  of  their  being  included  in 
the  manufacturing  overhead  and  thus  tend  to  obscure  the 
true  cost  of  manufacture  and  interfere  with  a  comparison  of 
costs  composed  of  like  items. 

There  would  appear  to  be  no  more  reason  for  including 
interest  on  capital  and  taxes,  than  rent,  in  manufacturing 
costs,  as  on  account  of  being  similar  to  rent,  they  are  more 
properly  chargeable  against  income. 

The  item  of  insurance  also  permits  of  some  discussion. 
It  is  argued  by  the  economists  that  insurance  is  not  a  true 
item  of  manufacturing  cost.  Insurance  is  a  premium  paid 
for  the  protection  of  capital,  and  being  an  expense  of  capital, 
considered  from  the  standpoint  of  the  business  as  a  whole, 
is  a  deduction  from  income.  Advancement  of  this  theory  is 
usually  confronted  with  the  query  as  to  why  the  salary  of 

64 


Distribution  Overhead  and  the  Bases  of  Distribution 

the  watchman  at  the  factory,  who  is  engaged  in  protecting 
the  capital  of  his  employer,  is  not  treated  as  a  deduction 
from  income  rather  than  a  part  of  manufacturing  expense. 

Having  disposed  rather  indefinitely  of  the  various  theo- 
ries covering  certain  of  the  items  making  up  the  overhead, 
they  may  now  be  considered  with  regard  to  those  which  fall 
within  the  control  of  the  operating  department,  and  with 
regard  to  certain  of  these,  those  which  may  be  said  to  fall 
specifically  within  the  control  of  the  foreman,  as  well  as  those 
which  do  not  fall  within  the  control  of  the  operating  depart- 
ment. They  may  be  listed  and  grouped  as  follows : 


Under  control  of  Operating  De- 
partment                          .    •    •  .  .x 

1  Under  control  of. 
foreman  

rHeat, 
Light, 
Power, 
Repairs  and  mainte- 
nance, 

*•»                      •        .                4 

Depreciation  of  ma- 
chinery and  tools. 

-Superintendence 

(Rent, 
Not  under  control  of  Operating  I  Taxes, 

Department ]  Insurance, 

Llnterest. 

It  will  now  be  necessary  to  consider  with  regard  to  the 
above  items  their  distribution  to  the  departments  and  the 
various  bases  upon  which  they  may  be  distributed.  There 
may  be  eliminated  from  this  class,  repairs  and  maintenance, 
and  depreciation  of  machinery  and  tools,  since  such  items 
are  local  in  their  origin  and  do  not  require  distribution. 

Heat  may  be  distributed  on  a  basis  of  cubic  yards,  after 
first  obtaining  the  cubic  contents  of  all  departments  receiving 
heat.  The  cost  of  heat  for  all  departments  is  divided  by  the 
number  of  cubic  yards  contained  in  same,  and  multiplying 
the  rate  thus  obtained  by  the  number  of  cubic  yards  in  each 
department,  to  ascertain  the  cost  of  heat  applicable  to  each. 

65 


Principles  of  Cost  Accounting 

The  distribution  of  light  depends  upon  whether  or  not 
facilities  for  measuring  same  by  meter  are  available.  Where 
electricity  is  used,  and  meters  are  found,  the  unit  of  measure- 
ment is  the  kilowatt  hour.  Where  gas  is  measured  by  meter, 
the  unit  of  measurement  is  the  cubic  foot.  Where  meters 
are  not  available  light  is  distributed  on  the  basis  of  square 
feet  of  floor  space. 

Power  is  apportioned  on  a  basis  of  horse-power  hours. 
This  unit  is  obtained  by  multiplying  the  horse-power  of  the 
machines  by  the  number  of  hours  in  operation. 

Superintendence  may  be  distributed  on  a  basis  of  direct 
labor  hours;  rent  on  a  basis  of  square  feet;  taxes  on  a  per- 
centage basis,  the  percentage  being  computed  on  the  value 
which  the  contents  of  any  given  department  bears  to  the  total 
assessed  value  of  all  departments. 

Insurance  may  or  may  not  permit  of  localization.  It 
should  be  localized,  if  possible;  if  impossible,  it  should  be 
distributed  on  the  basis  of  value.  Interest  should  likewise 
be  apportioned  on  the  basis  of  value. 

It  has  not  been  thought  necessary  to  repeat  in  each  in- 
stance the  formula  for  distribution,  on  account  of  being 
practically  the  same  in  each  instance  and  having  been  once 
given  in  connection  with  the  distribution  of  heat. 


66 


CHAPTER  XIV 

MACHINE  RATES 

Distribution  may  not  cease  with  departments.  Having 
allocated  the  items  of  expense  thus,  we  may  go  on  further 
and  redistribute  within  departments  to  processes,  to  ma- 
chines, or  to  individuals.  The  theory  being  in  each  case  the 
same,  but  as  applied  to  machines  slightly  more  interesting, 
we  may  proceed  with  its  application  thereto,  and  to  discuss 
the  question  of  machine  rates. 

The  subject  matter  for  distribution  will  depend  upon  the 
type  of  system,  and  may  embody  overhead  alone,  a  combi- 
nation of  labor  and  overhead,  or  a  still  further  combination 
of  material,  labor  and  overhead.  The  rates  are  of  two 
kinds — the  departmental,  sometimes  referred  to  as  the  "old" 
machine  rate,  and  the  allocated  rate,  sometimes  known  as 
the  "new"  machine  rate.  Either  may  be  a  fixed  rate  (de- 
veloped in  a  previous  period)  or  a  scientific  rate  (estimated) 
and  either  may  involve  one  or  two  supplementaries. 

In  order  to  find  the  departmental  rate,  it  is  necessary  to 
divide  the  actual  overhead  of  the  department  by  the  number 
of  actual  machine  hours  for  the  entire  department.  A  rate 
is  thus  obtained  which  furnishes  a  basis  for  distributing  the 
overhead  to. the  jobs,  in  accordance  with  the  number  of  ma- 
chine hours  shown  by  the  respective  jobs.  This  method  is 
satisfactory,  in  case  there  is  no  bench  work  and  the  machines 
are  of  the  same  type,  of  the  same  value,  occupy  the  same 
amount  of  floor  space,  and  use  the  same  amount  of  power. 

It  should  be  noted  that  this  method  pro-rates  the  over- 

67 


Principles  of  Cost  Accounting 

head.  Objection  to  it  is  found  in  that  it  does  not  sufficiently 
localize  the  overhead,  and  the  objection  gives  rise  to  a  de- 
mand for  a  method  which  will  permit  of  as  much  direct  dis- 
tribution as  is  possible.  To  supply  this  demand,  the  allo- 
cated machine  rate  was  evolved.  The  rate  here  is  obtained 
by  dividing  the  total  cost  of  labor  and  overhead  as  allocated 
to  individual  machines  by  the  number  of  hours  the  corre- 
sponding machines  are  in  operation.  The  cost  applicable  to 
the  jobs  in  question  is  obtained  by  multiplying  the  rate  by 
the  number  of  machine  hours  on  the  respective  jobs.  This 
method  may  be  used  to  advantage  where  the  majority  of 
processes  are  machine.  Bench  work,  of  course,  complicates 
matters,  and  attention  to  the  physical  arrangement  should  be 
given  in  order  that  machines  of  the  same  type  may  be  in 
the  same  group. 

The  fixed  rate  contemplates  the  use  of  one  determined 
upon  the  basis  of  actual  running  time  during  the  next  pre- 
ceding month  or  period.  The  charge  to  the  jobs  is  obtained 
by  multiplying  the  number  of  operating  hours  per  job  by  the 
rate  and  crediting  to  the  overhead  a  corresponding  amount. 
The  amount  so  credited,  which,  it  will  be  noted,  is  an  estimate 
based  on  past  experience,  will  be  offset  at  the  end  of  the 
current  month  or  period  by  the  actual  cost  during  the  period, 
and  as  usually  happens  a  difference  will  result. 

This  difference  may  mean  that  the  fixed  rate  upon  which 
the  charges  to  jobs  have  been  made  was  either  too  high  or 
too  low,  and  the  difference  must  be  distributed  either  as  a 
debit  or  a  credit  to  the  cost  of  the  jobs,  in  accordance  with 
whether  the  fixed  rate  was  too  high  or  too  low.  It  gives  rise 
to  what  is  known  as  a  supplementary  rate,  and  which  is  ob- 
tained by  dividing  the  "difference"  by  the  actual  number  of 
operating  hours.  The  redistribution  is  brought  about  by 

68 


Machine  Rates 

multiplying  this  supplementary  rate  by  the  number  of  actual 
operating  hours  shown  by  the  respective  jobs. 

The  scientific  rate  is  the  most  complicated,  but  produces 
the  most  satisfactory  results.  It  contemplates  the  estimating, 
or  predetermining,  of  certain  items  of  overhead  for  the  year 
or  period.  Among  these  are : 

Superintendence,  Depreciation, 

Heat,  Taxes, 

Light,  Insurance, 

Power,  Interest. 

The  scientific  rate  also  contemplates  operation  on  the 
basis  of  maximum  running  time  for  each  machine  during  the 
entire  year  or  period.  Items  of  overhead  are  first  distributed 
to  departments  and  subsequently  to  machines.  The  machine 
cost  is  then  divided  by  the  maximum  operating  hours  in  order 
to  get  a  rate  per  hour.  The  charge  to  jobs  is  obtained  by 
multiplying  the  number  of  actual  operating  hours  devoted 
to  the  job,  by  the  rate,  and  the  crediting  of  a  corresponding 
amount  to  the  overhead. 

Idle  time,  as  in  the  case  of  the  fixed  rate,  gives  rise  to 
the  necessity  for  further  distribution  and  the  obtaining  of 
what  is  known  as  the  first  supplementary  rate.  This  is  ascer- 
tained by  dividing  the  cost  of  the  idle  time  by  the  total  num- 
ber of  actual  operating  hours,  and  the  distribution  by  multi- 
plying the  first  supplementary  by  the  number  of  hours  on 
each  job.  As  jobs  are  charged  a  corresponding  credit  is 
made  to  the  overhead.  It  will  be  remembered  that  there 
are  now  two  credits  to  the  overhead,  one  arising  at  the  time 
of  applying  the  first  supplementary.  The  process  from  this 
point  is  precisely  the  same  as  in  the  case  of  the  fixed  rate. 
Actual  overhead  for  the  month  or  period  is  now  ascertained 
and  charged  to  the  overhead,  thereby  offsetting  the  credits 

69 


Principles  of  Cost  Accounting 

just  previously  mentioned  and  usually  resulting  in  a  difference 
between  the  actual  overhead  and  the  predetermined  over- 
head, plus  the  first  supplementary  rate.  The  manner  of  dis- 
posing of  this  difference  gives  rise  to  the  second  supplemen- 
tary rate,  which  is  obtained  by  dividing  this  difference  by  the 
actual  operating  hours  on  all  jobs  and  distributing  to  the 
jobs  in  accordance  with  the  number  of  hours  each  shows.  As 
this  last  supplementary  is  charged,  overhead  is  credited,  thus 
actually  balancing  the  overhead  account.  In  order  to  bring 
this  out,  reference  to  the  following  ledger  account,  as  well  as 
the  succeeding  illustration,  may  be  found  helpful  : 


OVERHEAD  ACCOUNT 


Actual $3,000 .  oo 


$3,000.00 


Machine  rate $2,000 . oo 

ist  Supplementary 400.00 

2d  "  600.00 


$3,000.00 


ILLUSTRATION 
Full  Time 


2,400  hours 
Actual  time 2,000     " 


400  hours 
2,000  hours)$4OO  .  oo 


Estimated  Overhead  Machine  Rate 
$2,400.00  $1.00 

Idle  hours  X  $1.00  =  $400.00. 


.  20  =  ist  Supplementary. 


$3,000  .  oo  =  Actual  overhead. 

2  ,400  .  oo  =  Estimated  overhead. 
2,000)  600.  00  =  Excess  to  be  distributed 
.  30  =  2d  Supplementary. 

575  Hours  720  Hours 


Job  No.  I 

575  X  $1.00  =$575.  oo 
575  X  .20=  115.00 
575X  .30=  172.50 

$862.50 


Job  No.  2 

72oX$r.oo=  $720.00 
720  X  .20=  144.00 
72oX  .30=  216.00 


$1,080.00 


705  Hours. 
Job  No.  3 

7osX$i.oo=  $705.00 
705  X  .20=  141.00 
705X  .30=  211.50 

$1,057.50 


$862.50 
i  ,080 . oo 
1,057-50 

$3,000.00 


CHAPTER  XV 
WAGE  SYSTEMS 

Before  entering  into  a  discussion  of  this  subject  a  few 
words  should  be  said  as  to  the  relation  of  wage  systems  to 
cost  accounting. 

The  success  of  a  professional  accountant  depends  in  a 
large  measure  upon  his  value  to  the  client.  His  value  is  dem- 
onstrated by  his  ability  to  save  the  client  money.  One  of  the 
principal  ways  of  saving  money  is  reducing  cost.  An  ac- 
countant should  therefore  be  in  a  position  to  indicate  to  the 
client  the  manner  in  which  costs  may  be  reduced.  Wage 
systems  undoubtedly  lower  costs,  and  the  accountant  in  order 
to  act  intelligently  and  be  of  most  value  to  his  client  should 
be  familiar  with  the  subject  and  the  relative  advantages  and 
disadvantages  of  the  various  systems. 

The  prophecy  may  also  be  made,  that  in  the  settlement 
of  the  ever-increasing  difficulties  between  capital  and  labor, 
wage  systems  will  not  be  an  insignificant  force. 

The  constant  struggle  of  to-day  is  to  effect  the  reduction 
of  tosts.  Why?  It  may  be  that  competition  requires  it,  or 
it  may  be  due  to  a  desire  on  the  part  of  the  manufacturer 
for  increased  profits. 

While  it  is  quite  evident  that  costs  may  be  reduced  by  the 
reduction  of  any  of  the  three  elements  composing  same,  it  is 
probable  that  the  item  of  labor  presents  greater  possibilities 
of  successful  reduction  than  either  of  the  two  other  elements. 

There  are  two  ways  in  which  labor  cost  may  be  reduced. 


Principles  of  Cost  Accounting 

The  first  is  through  the  reduction  of  wages.  The  second  is 
through  an  increase  in  the  production.  The  first  method 
produces  a  strenuous  objection  on  the  part  of  the  laboring 
man;  a  complaint  that  he  is  being  ill-treated,  or  perhaps  his 
refusal  absolutely  to  continue  at  reduced  rates.  The  second 
method  is  the  more  scientific  and  satisfactory  to  the  wage 
earner,  and  given  the  demand  for  unlimited  production,  is  to 
be  preferred  by  the  manufacturer. 

As  an  illustration,  whereby  the  same  result  is  accom- 
plished, reference  may  be  had  for  a  moment  to  the  tabulation 
which  appears  below  and  shows  the  application  of  the  two 
methods  to  the  casting  of  pin  trays. 

Workman      Wage         Production  Trays  Cost  Per  Unit 
1  $2.40  120  .02 

(1) 1  $1.80  120  .015 

(2) 1  2.40  160  .015 

Considering  $2.40  per  day  as  the  normal  wage  of  a  man 
who  produces  120  trays,  it  is  evident  that  the  cost  per  unit 
will  be  .02.  If  the  manufacturer  desires  to  reduce  the  cost  to 
.015,  he  may  accomplish  this  result  by  decreasing  the  wage  to 
$1.80,  assuming  that  the  production  remains  constant,  or  he 
may  allow  the  wage  to  remain  at  $2.40  and  insist  that  the 
operative  shall  increase  the  production  to  160  trays. 

The  reduction  of  the  wage  to  $1.80  brings  a  storm  of 
protest  from  the  operative.  Insistence  that  he  shall  increase 
his  production  causes  him  to  become  sullen,  and  perhaps 
complain  that  he  is  being  driven.  In  the  instance  where  his 
wage  is  reduced,  if  the  workman  continues,  it  is  probable 
that  he  will  "soldier,"  with  the  result,  perhaps,  that  the  pro- 
duction per  day  will  fall  from  120  to  90,  thus,  based  on  the 
wage  of  $1.80,  restoring  the  cost  to  .02. 

It  becomes  quite  evident,  then,  that  a  reduction  of  the 

72 


Wage  Systems 

wage  is  practically  out  of  the  question,  and  that  in  order  that 
the  cost  may  be  reduced,  the  production  must  be  increased, 
and  the  question  before  us  now  is  how  this  increase  shall  be 
accomplished. 

The  small  boy  who  is  paid  for  doing  chores,  does  them 
more  cheerfully  than  if  he  is  compelled  to  do  them  without 
compensation.  The  schoolboy  who  receives  a  quarter  from 
his  father  every  time  his  report  card  shows  100%  in  arith- 
metic, usually  does  better  work  in  arithmetic  on  account  of 
the  quarter  awaiting  him.  The  quarter  acts  as  an  incentive. 
Laboring  men  are  not  unlike  schoolboys  in  this  respect.  They 
will  do  more  work  per  day  and  they  will  do  better  work  per 
day,  if  some  incentive  is  offered,  than  if  driven  to  the  same 
result. 

Let  us  assume  that  the  incentive  offered  to  the  operative 
is  one-half  of  the  saving  brought  about  through  a  reduction 
of  the  costs.  It  is  not  unusual  to  find  that  men,  if  offered 
the  proper  incentive,  are  capable,  with  ease,  of  doubling  the 
production.  Under  such  a  condition,  with  a  normal  daily 
wage  of  $2.40  it  is  evident  that  the  cost  per  unit  would  be 
.01.  The  saving  per  unit  will  be  .01  which  if  equally  divided 
with  the  workman,  on  a  basis  of  240  units  produced,  will  give 
as  the  workman's  share  $1.20.  The  workman's  daily  wage 
will  then  be  $3.60,  while  the  net  cost  of  production  per  unit 
to  the  employer  will  be  .015. 

The  conclusion  to  be  drawn  from  the  above  is  that  the 
wage  system,  which  has  as  its  basis  the  sharing  of  savings 
with  the  employees,  has  accomplished  the  desired  result  of 
reducing  costs,  increased  the  wage  of  the  employee,  and 
thereby  proved  entirely  satisfactory  to  all  concerned. 

The  following  tabulation  may  bring  out  more  graphically 
the  preceding  statement: 

73 


Principles  of  Cost  Accounting 


Wage 

Production 

Cost 

Normal 

$2.40 

120 

.02 

Increased  Production 
%  Saving  to  work- 
man   

$2.40 
i  .20 

240 
2dO 

.OI 

.oos 

*tv 

.»""•»  J 

Workman  

S^.6o 

24.O 

QIC 

I 

*tv 

D5 

n 
c 

r  W 

e 
c 
rC 

e  a 

e  o 

a  g 
s  e                   s 

a  s 
t 

e   Wage  e 
System 

In  discussing  the  above,  the  question  is  often  asked,  Why 
not  as  an  alternative,  introduce  piece  rates?  Here  is  an  in- 
centive indeed.  The  benefit,  however,  accrues  largely  to  the 
workman.  It  is  true,  of  course,  that  there  will  be  a  certain 
amount  of  saving  in  the  overhead,  due  to  increased  produc- 
tion, but  that  no  saving  will  be  effected  so  far  as  the  labor  is 
concerned. 

One  hundred  and  twenty  units  at  .02  will  cost  $2.40, 
and  240  units  at  .02  will  cost  $4.80.  To  use  an  expression 
popular  in  connection  with  the  discussion  of  piece  rates,  oper- 
atives "work  their  heads  off." 

Piece  rates  ultimately  prove  unsatisfactory  to  the  work- 
man, because  of  the  fact  that  as  soon  as  the  wage  becomes 
excessive  it  is  sure  to  result  in  a  cut.  The  workman  thus 
becomes  dissatisfied  and  unconsciously  adopts  a  standard. 

Mr.  George  Frederick  Stratton,  writing  on  the  subject 
in  the  March,  1910,  number  of  "System,"  relates  the  fol- 
lowing incident: 

"A  young  man  secured  a  job  in  the  brass  finishing  depart- 
ment He  was  a  green  man  and  started  at  day  rates  to  learn 
polishing.  Specializing  on  such  work,  he  advanced  sufficient- 

74 


Wage  Systems 

ly  in  three  weeks  to  go  on  to  piece  work.  In  two  months  he 
jubilantly  exhibited  a  pay  check  calling  for  $14.00  and  was 
applauded  by  his  family.  'It's  pretty  good  now!  but  it's  as 
much  as  I'll  get  if  I  work  there  ten  years.'  'How's  that?' 
inquired  his  father.  'You're  on  piece  work  and  you'll 
surely  get  more  expert  as  the  time  goes  on.'  'Sure  thing,' 
retorted  the  young  man,  'but  $14.00  is  the  limit.  If  any 
man  runs  over  that  in  our  room,  he'll  get  his  head  punched — 
and  he'll  get  the  rates  cut,  too.'  ' 

Piece  rates  may  be  effectively  employed,  provided  the  in- 
centive is  restricted.  That  is  to  say,  an  incentive  may  be 
offered  to  increase  production,  if  the  rate  is  reduced  on  the 
surplus;  for  example: 

120  at  .02— $2.40 
120  at  .01—  1.20 
240  )  $3.60  (.01 5 

It  will  be  noted  from  the  foregoing  that  the  same  thing 
has  been  accomplished  in  the  application  of  piece  rates  to  the 
problem  that  resulted  previously  where  the  daily  wage  basis 
was  in  effect. 

The  application  of  the  broad  principle  in  the  first  instance 
is  frequently  seen  in  connection  with  machine  work.  Here 
reduction  in  cost  is  effected  through  a  saving  in  time,  rather 
than  an  increase  in  production.  If  the  average  or  normal 
time  required  for  the  accomplishment  of  a  certain  task  is 
eight  hours  and  the  rate  of  compensation  or  machine  cost 
is  .60  an  hour,  the  cost  of  the  job  will  be  $4.80.  If  by  close 
attention  to  his  work,  and  the  intelligent  application  of  all 
his  faculties,  a  workman  is  able  to  reduce  the  time  of  opera- 
tion to  six  hours,  it  is  quite  apparent  that  at  the  same  rate 
per  hour,  or  machine  cost  of  ;6o,  he  has  effected  a  saving 
of  $1.20.  Even  viewed  from  the  standpoint  of  equity,  there 

75 


Principles  of  Cost  Accounting 

would  appear  no  reason  why,  in  the  natural  order  of  things, 
the  workman  should  not  receive  some  benefit  accruing 
through  the  saving  of  $1.20  at  his  hands;  why  he  should 
not  receive  some  premium  or  bonus  for  having  accomplished 
this  saving. 

Whether  or  not  he  is  entitled  to  it  from  an  equitable  stand- 
point, it  is  certainly  good  judgment  on  the  part  of  the  em- 
ployer to  share  the  saving  with  him,  to  the  end  that  he  may 
have  some  incentive  for  continuing  his  efforts  to  lower  the 
cost.  If  he  receives  half  the  saving,  in  the  above  mentioned 
instances  it  will  amount  to  .60.  It  will  be  seen  that  his  day's 
pay,  assuming  that  he  does  no  further  work  after  accomplish- 
ing the  task  set,  will  be  made  up  of  two  elements;  one  being 
the  regular  wage  at  a  fixed  sum  per  hour,  and  the  other 
the  premium  or  bonus  for  the  saving  in  time,  amounting  re- 
spectively to  $3.60  and  .60,  or  a  total  of  $4.20  for  the  day, 
as  illustrated  herewith : 

8  hours  at  .60         =$4.80 
6     "       "  .60         =  3-60 


saving)  2  2)$i.2o 

premium     i  .60 

cost     7  .60         =$4.20 

This  work  taken  in  connection  with  an  eight  hour  day, 
leaves  the  operative  still  two  hours  in  which  to  work  on  an- 
other task  and  thereby  further  increase  his  daily  wage. 

It  should  be  borne  in  mind  that  increased  speed  and  in- 
creased production  give  rise  to  an  increase  in  the  amount  of 
defective  work  and  a  corresponding  need  for  the  establish- 
ment of  an  inspection  department. 

Most  wage  systems  are  constructed  on  the  principles  out- 
lined above,  and  while  some  arc  known  as  premium  systems 


Wage  Systems 

and  some  as  bonus  systems,  there  is  only  a  very  slight  techni- 
cal difference  between  these  two  terms.  The  word  "pre- 
mium" is  usually  employed  to  indicate  a  division  in  the  saving 
in  time,  whereas,  the  term  "bonus"  implies  an  increased 
rate  offered  for  speed  and  skill. 

Up  to  this  point,  the  discussion  has  been  confined  entirely 
to  the  reduction  of  cost  based  on  the  saving  of  labor.  We 
shall  also  have  to  consider  a  similar  saving  with  regard 
to  overhead,  or  to  overhead  in  conjunction  with  labor.  The 
most  common  type  of  system  which  takes  into  account  both 
labor  and  overhead,  has  for  its  basis  what  is  known  as  the 
differential  rate.  The  rate  per  hour  is  arranged  on  a  sliding 
scale  which  increases  in  proportion  as  the  number  of  units 
produced  increases.  The  workman  who  produces  12  units 
receives  a  proportionately  higher  rate  per  hour  than  the 
workman  who  produces  only  10  units.  The  system  operates 
to  the  advantage  of  the  efficient  workman  and  to  the  disad- 
vantage of  the  inefficient  workman.  It  is  said  to  "differenti- 
ate" between  the  good  workman  and  the  poor  workman.  On 
this  account  the  rate  is  known  as  the  "differential." 

While  it  will  be  seen  from  the  tabulation  herewith  sub- 
mitted that  the  increase  in  the  number  of  units  produced 
carries  with  it  an  increase  in  the  rate,  and  a  consequent  in- 
crease in  the  wage  of  the  operative,  a  consideration  of  the 
units  taken  in  connection  with  the  overhead  will  show  that 
as  the  units  of  production  increase,  the  overhead  decreases. 

DIFFERENTIAL  RATE 

Overhead $13.20 

Labor  Cost  Overhead  Cost  Cost  per  Unit 

10  units  at  .30  =  $3.00  $1.32  $1.62 

10     "      "  .32=  3.52  1.20  1.52 

12     "      "  .34=  4.08  1. 10  1.44 


8  units  at  .26  =$2.08  $1.65  $1.91 

77 


Principles  of  Cost  Accounting 

The  advantages  of  the  differential  rate  are  that  it  offers 
an  incentive  to  the  workman  and  increases  his  wage  if  he 
takes  advantage  of  it. 

From  the  standpoint  of  the  employer  it  is  equally  advan- 
tageous, in  that  it  decreases  cost  by  increasing  production, 
and  in  general  raises  the  standard,  by  enabling  the  employer 
to  distinguish  between  the  efficient  and  inefficient  workman. 


CHAPTER  XVI 

THE  FIXING  OF  WAGE  RATES 

The  success  of  all  wage  systems  depends  upon  the  fixing 
of  rates.  Before  a  rate  may  be  fixed  it  is  necessary  to  deter- 
mine, 

1.  Which  are  the  best  methods  and  tools  to  use. 

2.  What  length  of  time  is  required  by  the  workman  of 

average  capacity  to  perform  a  task  without  un- 
due exertion? 

The  necessity  for  this  sort  of  thing  was  first  seen  about 
thirty  years  ago,  by  Mr.  Frederick  W.  Taylor,  who  was  at 
that  time  connected  with  the  Midvale  Steel  Co.  Mr.  Taylor 
went  about  the  task  of  gathering  statistics  and  classifying 
them  in  a  scientific  manner,  so  as  to  permit  of  their  use  in 
determining  the  best  methods  and  tools  to  use,  and  the  time 
required  for  the  performance  of  specific  tasks.  In  a  paper 
on  the  subject  of  Shop  Management,  Mr.  Taylor  makes  the 
statement  that  the  two  facts  which  appear  most  noteworthy 
in  connection  with  the  method  of  Shop  Management  are: 

"First — What  may  be  called  the  great  unevenness  or  lack 
of  uniformity  shown  even  in  our  best  run  works,  in  the  de- 
velopment of  the  several  elements  which  together  constitute 
what  is  called  the  management" 

"Second — The  lack  of  apparent  relation  between  good 
shog  management  and  the  payment  of  dividends." 

"The  art  of  management  has  been  defined  as  knowing  ex- 
actly what  you  want  men  to  do  and  then  seeing  that  they 

79 


Principles  of  Cost  Accounting 

do  it  in  the  best  and  cheapest  way.  What  the  workmen  want 
from  their  employers  beyond  anything  else,  is  high  wages, 
and  what  employers  want  from  their  workmen  most  of  all,  is 
a  low  cost  of  manufacture.  The  possibility  of  coupling  high 
wages  with  a  low  labor  cost  rests  mainly  upon  the  enormous 
difference  between  the  amount  of  work  which  a  first-class 
workman  can  do  under  favorable  circumstances,  and  the 
work  which  is  actually  done  by  the  average  man.  First-class 
men  are  not  only  willing  but  glad  to  work  at  their  maximum 
speed,  provided  that  they  are  paid  from  30%  to  100%  more 
than  the  average  of  their  trade."  Having  in  mind  the  above 
facts,  Mr.  Taylor  made  a  careful  study  of  the  best  methods 
and  tools  to  use,  and  evolved  a  system  for  standardizing  the 
time  of  operations  which  may  be  best  described  in  his  own 
words,  as  follows: 

"In  1883  while  foreman  of  the  machine  shop  of  the  Mid- 
vale  Steel  Company  of  Philadelphia,  it  occurred  to  the  writer 
that  it  was  simpler  to  time  with  a  stop-watch  each  of  vhe  ele- 
ments of  the  various  kinds  of  work  done  in  the  place,  and 
then  find  the  quickest  time  in  which  each  job  could  be  done, 
by  summing  up  the  total  times  of  its  component  parts,  than 
it  was  to  search  through  the  time  records  of  former  jobs  and 
guess  at  the  proper  time  and  price.  After  practicing  this 
method  of  time  study  improvements  for  about  a  year,  as 
well  as  the  circumstances  would  permit,  it  became  evident 
that  the  system  was  a  success.  The  writer  then  established 
a  time  study  and  rate  fixing  department,  which  has  given 
out  piece  work  prices  in  the  place  ever  since." 

The  Taylor  system,  while  it  imposes  upon  the  manage- 
ment the  burden  of  seeing  that  the  work  is  done  in  the  time 
and  manner  specified,  also  provides  a  higher  rate  for  in- 
creased efficiency. 

80 


The  Fixing  of  Wage  Rates 

In  1886  Mr.  Henry  Towne  originated  a  wage  system 
which  was  improved  and  made  practical  by  Mr.  F.  A.  Hal- 
sey,  who  in  1891  described  the  system  in  a  paper  before  the 
American  Society  of  Mechanical  Engineers.  The  Towne- 
Halsey  system  contemplates  as  a  standard  the  quickest  time 
in  which  a  job  has  been  done.  The  workman  who  does  it 
in  the  shorter  time  receives  the  same  wage  per  hour  for  the 
time  he  is  engaged  upon  the  job,  and  in  addition  a  premium 
for  having  worked  faster,  which  ranges  from  one-quarter  to 
one-half  of  the  saving  in  time. 

It  may  be  stated  here,  that  scarcely  any  system  has  yet 
been  evolved  to  which  there  has  been  no  objection  raised. 
An  objection  was  raised  to  the  Halsey  system  in  that  the  rate 
became  excessive  after  $0%  had  been  saved. 

In  1901  Mr.  James  Rowan  read  a  paper  before  the  me- 
chanical section  of  the  International  Engineering  Congress, 
in  which  he  advocated  the  allowance  of  a  bonus  based  on 
such  a  percentage  of  the  regular  wage  as  the  time  saved  bears 
to  the  standard  time.  For  example,  if  the  standard  time  for 
the  operation  were  one  hour,  and  the  standard  wage  .30,  a 
saving  of  six  minutes  would  be  equivalent  to  10%,  and  10% 
of  .30,  or  .03,  added  to  the  standard  wage  would  give  as  the 
wage  per  hour  .33.  Objection  was  found  to  this  system,  that 
the  bonus  was  too  great  in  proportion  to  the  saving  during 
the  first  hours  saved. 

Among  other  systems  which  have  gained  both  notice  and 
popularity  are: 
Cardullo, 

Searle  &  Nicholson, 
Gantt, 
Emerson. 

Under  the  Cardullo  system  the  wage  is  arranged  on  a 


Principles  of  Cost  Accounting 

sliding  scale  based  on  the  percentage  of  time  saved,  but  is 
limited  by  the  maximum,  no  matter  how  much  time  is  saved. 

Searle  &  Nicholson  advocate  a  system  whereby  the  work- 
man receives  one-half  the  time  saved  until  the  saving  reaches 
50%,  thereafter  a  percentage  based  on  the  ratio  which  the 
time  saved  bears  to  standard  time.  This  is  a  combination 
of  the  Halsey  &  Rowan  methods  and  would  seem  to  over- 
come the  objections  found  to  both. 

The  Gantt  system  does  not  differ  materially  in  principle 
from  the  other  systems,  except  that  in  addition  to  the  reward 
for  efficiency  offered  to  the  operative,  and  which  Mr.  Gantt 
specifies  shall  be  liberal,  the  reward  shall  be  extended  to  those 
who  supply  the  operative  with  materials  and  appliances  to 
enable  him  to  maintain  the  efficiency  specified. 

Before  discussing  the  Emerson  system,  which  serves  as 
an  introduction  to  the  next  topic,  a  few  words  may  be  said 
concerning  the  various  profit-sharing  and  stock-distributing 
systems,  which  are  coming  largely  into  vogue.  Rewards  of 
this  description  are  intended  to  promote  co-operation  and  act 
as  an  incentive  to  the  workman;  to  decrease  cost  by  increas- 
ing production.  They  are  not  as  a  rule  entirely  successful. 
They  fail  usually,  so  far  as  the  workmen  are  concerned,  be- 
cause of  the  fact  that  the  profits  do  not  depend  entirely  upon 
the  workman.  A  saving  may  be  made  by  the  manufacturing 
department  through  a  reduction  of  cost  whereby  profits  are 
insured,  only  to  have  such  profits  dwindle  on  account  of  the 
shortsightedness  on  the  part  of  the  selling  organization,  or 
through  poor  judgment  on  the  part  of  an  administrative 
officer.  This  objection  may  be  overcome,  however,  by  fixing 
a  standard  cost  at  which  the  product  is  credited  to  the  manu- 
facturing department;  any  reduction  in  this  cost  being  con- 
sidered as  a  saving  attributed  to  the  manufacturing  depart- 

82 


The  Fixing  of  Wage  Rates 

ment  and  a  part  thereof  set  aside  and  distributed  among  the 
men  as  profits.  Notwithstanding  the  fact  that  the  general 
objection  has  been  overcome,  these  systems  are  usually 
deemed  to  be  unfair  and  inequitable,  since  it  usually  occurs 
that  the  men  who  contribute  most  to  the  profit  get  the  smallest 
share  thereof.  Workmen  as  a  rule  prefer  individual  return 
for  individual  effort,  which  the  wage  system  accomplishes. 

Mr.  Harrington  Emerson  recognized  this  tendency  of 
human  nature  when  he  originated  the  Individual  Effort  Sys- 
tem. 

The  Emerson  System  became  famous  in  connection  with 
its  adoption  and  use  in  the  shops  of  the  Santa  Fe  Railroad, 
to  the  extent  that  it  is  popularly  known  as  the  Santa  Fe  Sys- 
tem. The  essentials  of  the  Emerson  System  are: 

A.  Standard  time,  or  time  in  which  the  work  should 

be  done; 

B.  A  premium  for  efficiency. 

The  premium  begins  at  66%  efficiency  and  gradually  in- 
creases until  1 00%  efficiency  is  reached,  in  which  case  the 
premium  equals  20%.  Above  100%  efficiency  the  premium 
increases  rapidly,  constituting  an  increase  of  i%  premium  for 
each  increase  of  i%  in  the  efficiency. 


CHAPTER  XVII 
THE  EFFICIENCY  DEPARTMENT 

One  of  the  most  striking  innovations  of  recent  times  is 
that  of  the  so-called  efficiency  department.  It  is  mentioned 
here,  on  account  of  the  close  relation  which  it  bears  to  Cost 
Accounting.  It  is  presided  over  by  the  efficiency  engineer, 
whose  duty  it  is  to  determine  the  measure  of  return  which 
the  employer  shall  receive  for  the  money  which  he  employs 
in  manufacturing  operations. 

The  housewife  who  purchases  in  the  market  a  bushel  of 
potatoes  for  one  dollar,  expects  to  receive  in  return  the  stand- 
ard of  quantity  as  well  as  the  standard  of  quality.  It  is  con- 
sidered equally  appropriate  that  the  entrepreneur  who  in- 
vests a  dollar  in  manufacturing  operations  should  expect  to 
receive  a  standard  return  of  quantity  and  quality. 

It  is  the  duty  of  the  efficiency  engineer  to  endeavor  to 
bring  this  about.  His  function  is  to  fix  standards  of  quantity 
and  quality.  Just  as  the  mining  engineer  makes  an  assay  of 
ore,  so  the  efficiency  engineer  tests  the  quantity  and  quality 
of  the  material  used  as  well  as  the  quantity  and  quality  of 
workmanship.  He  must  have  a  broad  knowledge  of  the  four 
elements  of  organization,  namely: 

Machinery, 

Men, 

Materials, 

Methods. 

He  is  the  chief  of  staff,  whose  assistants  are  specialists  in 

84 


The  Efficiency  Department 

the  above  mentioned  lines.  The  staff  determines  what  shall 
be  done  and  prescribes  the  methods  for  accomplishing  the 
work. 

The  line  organization  performs  the  work  in  accord- 
ance with  the  methods  prescribed,  and  has  always  at  its  com- 
mand highly  specialized  staff  knowledge  upon  which  it  may 
call  for  assistance. 

Under  such  an  organization,  each  branch  of  the  work  is 
in  charge  of  one  of  the  assistants. 

The  man  in  charge  of  machinery  has  as  his  duty  the 
standardization  of  all  machinery  and  equipment.  To  him 
is  assigned  the  task  of  securing  the  proper  types  of  machines 
and  tools  which  are  the  most  efficient.  He  advises  as  to  their 
care  and  decides  upon  the  location  of  each,  with  a  view  to  se- 
curing the  most  effectual  progress  of  the  work  through  the 
plant.  One  case  is  reported  where  a  40%  increase  in  the  out- 
put was  secured  by  a  rearrangement  of  machines. 

Another  assistant  chief  of  staff  looks  after  men  and  con- 
ditions, which  is  one  of  the  most  interesting  as  well  as  the 
most  difficult  branches  of  the  work.  He  supervises  the  stand- 
ardizing of  conditions  and  requirements  that  fall  within  the 
scope  of  his  duties.  He  plans,  directs  and  advises  as  to 
the  welfare  of  the  employes.  He  sees  to  it  that  be- 
fore an  employee  is  engaged,  he  submits  to  examination  as 
to  his  moral,  physical  and  professional  qualifications.  Emer- 
son goes  to  the  extent  of  saying  that  "it  ought  to  be  as  diffi- 
cult to  enter  the  services  of  a  great  corporation  as  to  pass 
the  entrance  examination  to  West  Point;  but  once  in,  it  ought 
to  be  a  catastrophe  for  a  man  to  be  forced  to  leave ;  because 
the  company  provides  so  much  that  he  cannot  provide  him- 
self, for  his  physical,  financial  and  professional  welfare,  and 
because  it  rewards  individual  efficiency." 

85 


Principles  of  Cost  Accounting 

Great  attention  is  being  paid  in  these  days  to  the  welfare 
of  employees.  Great  corporations  as  well  as  individual  em- 
ployers are  giving  more  attention  to  providing  better  light 
and  better  air.  Many  manufacturing  plants  are  equipped 
with  automatic  exhausts  for  the  removal  of  dangerous  parti- 
cles of  dust,  which  heretofore  have  been  allowed  to  fill  the 
atmosphere  in  which  the  employees  worked.  Overcrowding 
of  work  rooms  is  being  avoided  and  operatives  are  provided 
with  a  place  to  wash  and  bathe,  and  in  many  instances  com- 
fortable dining  rooms  in  which  to  eat.  Medical  attention  is 
furnished  and  ample  means  of  escape  from  the  buildings  in 
case  of  fire  provided.  In  order  that  ample  opportunity  for 
recreation  may  be  had,  club  rooms  and  club  houses,  with 
billiards,  pool,  bowling  and  all  other  appurtenances  thereto, 
are  provided  by  the  company  free  of  charge.  In  some  cases 
the  club  house  contains  an  auditorium  where  entertainments 
are  held  and  lectures  are  given.  One  Western  company 
went  so  far  as  to  provide  and  equip  a  first-class  bar,  on  the 
theory  that  the  men  would  have  liquor  and  the  company  pre- 
ferred that  they  should  have  good  liquor  rather  than  poor. 

Materials  are  looked  after  by  another  assistant  chief  of 
staff,  who  controls  both  the  purchasing  agent  and  the  stores 
department.  He  standardizes  the  material  to  be  used  and 
specifies  the  kind  and  quality  to  be  purchased.  He  prescribes 
the  methods  necessary  for  its  care,  to  the  end  that  it  may  not 
deteriorate,  be  wasted  or  be  used  extravagantly. 

The  man  in  charge  of  methods,  prescribes  the  methods 
whereby  standards  may  be  attained.  It  is  his  duty  to  advise 
workmen  as  to  the  most  efficient  use  of  equipment,  machines 
and  tools.  In  short,  he  is  called  upon  to  provide  methods 
which  will  result  in  doing  the  most  work  in  the  shortest  time 
and  better  work  with  less  effort. 

86 


The  Efficiency  Department 

The  efficiency  organization,  of  course,  requires  records 
and  accounting.  Records  are  needed  of  machines,  as  to  their 
installation,  operation  and  maintenance.  It  is  especially 
necessary  that  breakdowns  and  repairs  shall  be  recorded, 
with  regard  to  materials,  a  record  of  the  purchases,  issues 
and  amounts  consumed;  as  to  work  performed,  both  the 
quantity  and  quality. 

An  authority  on  this  subject  states  that  it  is  impossible  to 
maintain  either  standards  or  records,  unless  they  are  tied 
into  the  cost  accounting. 

Standards  serve  to  develop  a  predetermined  cost.  Tak- 
ing into  consideration  the  cost  of  material  as  determined  by 
the  standards  of  quantity  and  quality,  the  cost  of  labor  as 
determined  by  the  standard  time  of  operation,  the  cost  of 
the  overhead  as  determined  by  the  standard  of  the  various 
elements  composing  it,  it  is  possible  to  predetermine  or  ob- 
tain an  estimated  cost  which  may  be  used  as  a  standard  or 
basic  cost  and  which  provides  for  100%  efficiency. 


87 


CHAPTER  XVIII 

RECONCILING   PREDETERMINED  AND   ESTIMATED   COSTS 
WITH  ACTUAL  COSTS 

As  a  matter  of  fact,  experience  shows  that  there  is  fre- 
quently a  wide  difference  between  the  ideal  or  standard  and 
the  actual.  What  should  be  is  one  thing,  and  what  has  been 
is  another.  Broadly  speaking,  it  may  be  said  that  standards 
cannot  be  maintained.  Failure  to  maintain  them  is  due  to — 

1.  Inefficient  material — material  which  is  below  the 

standard  of  quality  and   requires  more   than 
standard  of  quantity. 

2.  Inefficient    labor,     due    to    inefficient    workmen, 

methods  or  conditions. 

Cost  accounting  is  required  because  of  inefficiency.  It 
is  the  duty  of  the  efficiency  engineer  to  say  what  the  cost 
should  be.  It  is  the  duty  of  the  cost  accountant  to  say  what 
the  cost  has  been. 

At  this  point  a  solution  of  the  problem  as  to  how  a 
reconciliation  may  be  effected  between  predetermined  costs 
or  estimated  costs  on  the  one  hand  and  actual  costs  on  the 
other,  presents  itself. 

Predetermined  costs  should  be  technically  distinguished 
from  estimated  costs,  in  that  they  are  constructed  from  pre- 
determined standards  scientifically  obtained,  whereas  esti- 
mated costs  are  purely  hypothetical  and  are  founded  on  the 
assumption  that  the  costs  for  the  current  period  will  be  the 
same  as  those  of  the  next  preceding  period. 

88 


Reconciling  Predetermined  With  Actual  Costs 

As  an  illustration  of  the  reconciliation  between  estimated 
cost  and  actual  cost,  attention  is  invited  to  the  facts  contained 
in  the  following  tabulation : 

Total         Material          Labor       Overhead 


Joh 

No    1  

$3  080 

$1200 

$1  600 

$280 

« 

"     2  

2  200 

1  000 

1000 

200 

$5,280 

$2,200 

$2,600 

$480 

The  application  of  the  principle  to  contract  work,  with 
which  everyone  is  more  or  less  familiar,  will  perhaps  serve 
to  make  the  illustration  clearer.  It  should  be  noted  that  the 
accounts  which  we  are  about  to  reconcile  are  those  contained 
in  the  general  ledger,  and  the  question  before  us  is :  how  we 
may  carry  in  the  general  ledger  estimated  or  predetermined 
costs,  without  interfering  with  the  actual  costs  as  developed 
by  the  financial  accounts,  and  at  the  same  time  bring  them 
into  agreement  at  the  end  of  the  period.  This  is  accom- 
plished, so  far  as  the  estimated  costs  are  concerned,  through 
the  medium  of  two  accounts,  namely: 

Cost  of  contracts; 

Reserve  for  cost  of  contracts. 

It  is  usually  possible  to  obtain  from  a  contract  book, 
wherein  the  estimates  of  the  jobs  are  listed,  a  total  of  the 
entire  estimated  cost  for  all  jobs  during  the  period.  From 
these  figures,  which,  in  the  case  of  the  above  tabulation, 
amount  to  $5,280,  the  following  journal  entry  may  be 
framed : 

Cost  of  contracts $5,280 

To  Reserve  for  cost  of  contracts .  .  $5,280 

Let  us  assume  that  at  the  end  of  the  period  the  actual  cost 
of  the  two  contracts  above  mentioned  is  $5,780.     This 

89 


Principles  of  Cost  Accounting 

amount  will  have  been  charged  to  "Reserve  for  cost  of  con- 
tracts" concurrently  with  the  credits  to  material,  labor  and 
overhead.  By  reference  to  the  following  ledger  accounts  it 
will  be  seen  that  the  account  "Reserve  for  cost  of  contracts" 
would  at  this  point  show  a  debit  of  $5,780  and  a  credit  of 
$5,280,  and  the  difference  between  the  two  sides  of  the  ac- 
count would  indicate  the  extent  to  which  the  estimate  was  in- 
correct. 

Dr.       Cost  of  Contracts       Cr.  Reserve  for  Cost  of  Contracts 


Estimated...  $5,280 
Reserve..  500 


$5,780 


$5,280 
500 


In  order  to  effect  the  reconciliation,  which  will  close  out  the 
"Reserve  for  cost  of  contracts"  and  make  the  "Cost  of  con- 
tracts account"  show  the  actual  cost,  a  second  journal  entry 
in  the  amount  of  $500  is  necessary. 

Cost  of  contracts $500 

To  Reserve  for  cost  of  contracts $500 

The  matter  of  reconciliation  would  be  comparatively 
simple  if  the  question  of  uncompleted  contracts  were  not  in-, 
volved.  This  difficulty  may  be  overcome  by  treating  the  un- 
completed contracts  as  inventories  in  the  case  of  both  ac- 
counts involved,  and  proceeding  as  before.  The  above 
method  of  handling  these  accounts  becomes  more  valuable 
when  the  principles  applied  to  the  cost  in  total  are  applied 
to  the  elements  making  up  the  cost.  Under  such  circum- 
stances the  journal  entry  for  placing  the  estimated  cost  on 
the  books  would  be  as  follows : 

Estimated  cost  of  uncompleted  contracts $5,280 

To  Reserve  for  material,  uncompleted  contracts 2,200 

"          "        "    labor,                 "                 "         2,600 

"    overhead,          "                 "          480 

90 


Reconciling  Predetermined  With  Actual  Costs 

Assuming  that  at  the  end  of  the  period  job  No.  i  is  com- 
pleted and  job  No.  2  uncompleted,  the  proper  steps  are,  first, 
to  deduct  the  items  involved  in  the  above  journal  entry  af- 
fecting job  No.  2  and  bring  them  down  as  inventories.  As- 
suming further  that  the  total  actual  cost  of  job  No.  I  is 
$3,280,  distributed  as  follows: 

Material $1,200 

Labor 1,600 

Overhead 480 

the  proper  journal  entry  would  be : 

Reserve  for  material,  uncompleted  contracts $1,200 

"    labor,  "  "          1,600 

"    overhead,          "  "          480 

To  Material  labor  and  overhead $3,280 

It  will  then  be  apparent  that  by  posting  the  above  journal 
entries  to  the  proper  ledger  accounts  that,  as  to  the  material 
and  labor  in  job  No.  I,  both  have  been  correctly  estimated, 
but  that  the  overhead  has  been  underestimated  in  the 
amount  of  $200.  The  proper  journal  entry  for  effecting  the 
reconciliation  is  as  follows: 

Cost  of  contracts $3,280 

To  estimated  cost  of  uncompleted  contracts $3,080 

Reserve  for  overhead,  uncompleted  contracts..  .         200 

A  further  illustration  of  the  application  of  these  principles 
will  be  found  in  the  following  tabulations  and  journal  en- 
tries. The  journal  entries  may  be  used  in  cases  where,  in 
the  absence  of  a  cost  system,  it  is  desired  to  point  out  to  a 
client  engaged  in  contracting  the  measure  of  inaccuracy  on 
the  part  of  his  estimating  department. 

9* 


Principles  of  Cost  Accounting 

No.  1 $10,000  ~|    Estimated  cost 

"    2 20,000   L  of 

"    3 25,125  J   various  contracts. 

$55,125 

FIGURES  SHOWN  BY  GENERAL  BOOKS 

12/31/08  Purchases  12/31/09      Cost 

Inventory,  material $3,000      $25,000      $2,000      $26,000 

"          uncompleted  jobs ....       15,000      14,000          1,000 

Labor 18,000      18,000 

$45,000 
Overhead,  various  items 13,500 


Actual  cost $58,500 

Cost  of  contracts  (estimated) $55,125 

To  Reserve  for  cost  of  contracts $55,125 

Reserve  for  cost  of  contracts 58,500 

To  Material,  labor,  etc 58,500 

Cost  of  contracts 3,375 

To  Reserve  for  cost  of  contracts. 3,375 


CHAPTER  XIX 
THE  REPORT  OF  THE  COST  DEPARTMENT 

It  will  be  remembered  that  at  the  beginning  of  the  first 
chapter  it  was  proposed  to  discuss  three  topics.  These  topics 
embraced  the  nature  of  the  information  being  sought,  the 
means  of  obtaining  the  information,  and  the  use  to  which 
the  information  is  to  be  put  after  it  has  been  obtained.  The 
first  topic  was  covered  by  an  inquiry  into  the  objects  in  as- 
certaining costs  and  which,  briefly  summarized,  are  to  make 
them  serve  as  a  basis  for  fixing  selling  prices  and  to  furnish 
information  to  the  proprietor  or  administrative  officer  which 
will  be  of  help  to  him  in  deciding  upon  administrative  poli- 
cies. Such  policies  may  include  determining  which  lines  of 
production  or  merchandise  are  profitable,  and  which  are  un- 
profitable, and  instituting  methods  which  will  reduce  costs. 
A  discussion  of  the  means  of  obtaining  the  information 
would  appear  to  have  been  covered  by  reference  to  the  sys- 
tem employed  for  gathering  the  information,  and  there  re- 
mains to  be  explained  the  use  to  which  the  information  is 
to  be  put  after  it  has  been  obtained. 

Obviously,  the  party  in  interest  is  the  proprietor  or  ad- 
ministrative officer.  The  information  which  he  seeks  is  that 
which  will  enable  him  to  draw  quickly  a  conclusion  from  cer- 
tain facts  presented  to  him  concerning  the  costs.  As  a  rule 
he  is  not  a  man  whose  time  and  patience  will  permit  of  delv- 
ing through  voluminous  books  and  records  for  this  informa- 
tion. It  must  be  summarized  and  placed  before  him  so  that 

93 


Principles  of  Cost  Accounting 

its  full  significance  will  be  evident  at  a  glance.  The  medium 
for  presenting  the  information  in  such  summary  form  is  the 
cost  sheet,  or  the  report  of  the  cost  department.  The  con- 
struction of  the  cost  sheet  will  depend  largely  upon  the 
nature  of  the  information  desired  by  the  proprietor. 

Regardless,  however,  of  circumstances,  it  is  always  es- 
sentially a  statistical  report  and  is  based  on  unit  costs.  The 
units  will  vary,  in  some  cases  dozens,  in  others  tons,  in  others 
single  units,  and  in  still  others  the  unit  may  be  the  contract 
or  job.  Depending  upon  the  use  to  which  the  information 
is  to  be  put,  the  cost  sheet  may  be  compiled  on  a  production 
or  on  a  sales  basis.  The  amount  of  detail  which  it  carries 
will  depend  upon  the  extent  to  which  the  administrative  offi- 
cer uses  it  as  an  index  to  operating  efficiency.  Generally 
speaking,  the  cost  sheet  must  show  distinctly  with  regard 
to  unit  costs  the  material,  labor,  and  the  overhead.  In  order 
to  show  the  relation  of  the  various  elements  of  the  material 
cost  to  the  total  material  cost,  it  may  sometimes  be  neces- 
sary to  present  in  classified  form  all  the  materials  involved. 
Such  an  arrangement  is  admirably  adapted  to  comparison. 
At  times  it  may  be  interesting  for  administrative  and  com- 
parative purposes  to  show  the  various  labor  departments 
separately.  The  proprietor  may  also  be  interested  in  know- 
ing all  the  items  which  make  up  the  overhead. 

For  the  purpose  of  fixing  a  selling  price  and  the  super- 
vision of  operations,  a  cost  sheet  on  a  production  basis, 
that  is  to  say,  one  showing  the  unit  cost  of  finished  goods 
orders,  is  usually  sufficient.  If  it  is  the  desire  of  the  manage- 
ment to  ascertain  the  profit  on  various  contracts,  or  various 
orders,  a  cost  sheet  showing  this  information  is  very  much 
more  difficult  of  accomplishment  and  much  more  complex. 
The  difficulty  lies  in  that  a  shipping  order  may  comprise 

94 


The  Report  of  the  Cost  Department 

various  qualities,  or  classes  of  goods  coming  from  various 
production  or  finished  goods  orders  wherein  the  cost  varies, 
and  it  becomes  necessary  to  assemble  the  unit  cost  of  the 
various  finished  goods  orders  in  order  that  the  total  cost 
of  the  shipping  order  may  be  ascertained  for  comparison 
with  the  sales  price  to  show  the  profit  on  the  order  in  ques- 
tion. 

The  general  arrangement  of  the  cost  sheet  is  illustrated 
in  a  form  to  be  found  on  page  96.  It  is  presented  in  the 
simplest  possible  form  in  order  that  the  principles  under- 
lying its  construction  may  be  readily  seen. 


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of  CALIFORNIA 

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LOS  ANGELES 
LIBRARY 


